Robert Lenzner of Forbes advises that you and I will be blindsided by the next financial crisis. Lenzner bases his reasoning on Yale economist Gary Gorton’s recent book Misunderstanding Financial Crises, Why We Don’t See Them Coming. According to Gorton the old-fashioned bank run is back, only in a different form. The recent financial crisis was different from earlier ones in that it was not initiated by bank depositors scrambling to withdraw their funds. Rather it was precipitated by a “run” among short-term lenders who had purchased banks’ commercial paper or lent money to banks through “repos” (repurchase agreements). When these lenders suddenly tried to liquidate these assets by selling them or not renewing the loans, their actions deprived banks of the short-term funds that the banks had been using to finance their long-term lending and investments.
As Lenzner describes the evolution of the crisis:
What transpired in 2007-08 “resembled the bank runs of the pre-Federal Reserve era. These were primitive expressions of panic by people trying desperately to sell assets, driving the price of those assets down, and causing other people to panic as well and try to get out at the same time. The panic spread from short-term instruments like repos and commercial paper to bonds and stocks and commodities and real estate. The wave of fear sweeps from short-term investments to longer term obligations. [There is an open quotation mark in this passage before "resembling" but no closed quotation mark to indicate where the quotation from Gorton ends.]
Lenzner goes on to warn:
The playbook in the next crisis will be the same as it was in past crises from 2008 to 1987, 1929, 1907, 1893, 1857 and so on. The run on the banks becomes systemic as no one institution is spared. Credit markets freeze, the economy goes south, millions lose their jobs, and other millions have their savings decimated. It happened time and time again in the 19th century before there was a central bank, and panics didn’t stop after the Fed appeared in 1913. . . .
Expect it to happen again. Gorton warns clearly that “there is no mechanism for determining when there actually is a crisis.” In fact, there was no panic by depositors in Citibank, BankAmerica, Wells Fargo that would have alerted the nation. It required the Fed to realize how over-leveraged, under-capitalized and insolvent major banks had become before it acted to rescue them with huge monetary bailouts.
So, in other words, federal deposit insurance no longer works to discourage or mitigate bank runs, because it does not cover short-term lenders. It will take massive money creation and bailouts by the Fed to defend against and cope with future bank runs by skittish investors.
All this is a great source of worry to Lenzner who pessimistically concludes:
We cannot afford for the market to lose confidence and for lenders (not depositors) to pull all their funds from one or more banks. Without the steady substantial continuation of short term funds the major banks cannot meet their longer term liabilities, and you could very well have another crisis begin. The unavoidable conclusion is that we have to focus on the continued stability of funding for the banks as much as strengthening their capital resources.
This is welcome news, indeed, to those advocates of free banking like myself who see the ever-present threat of bank runs as the one and only effective means of discouraging fractional-reserve banks from issuing un-backed deposits, or “fiduciary media,” and systematically mismatching the maturity profiles of their liabilities and assets (“borrowing short and lending long”). It is the creation and lending of fiduciary media that falsifies the interest rate and thereby causes the recurrence of booms and busts. If the Fed and the financial elites are unable to figure out a way of ensuring “stability of funding for the banks,” the scam will be up and the turbulent and destructive era of fractional-reserve banking will come to a rapid and well-deserved close.