Thursday, September 11, 2008

Lehman Brothers Next To Fall

I am trying to keep the focus away from traditional financial markets, but I can't help but remark up on the news that Lehman Brothers is the next financial firm to fail. The New York Times and Washington Post offer some more perspective. The sum of what I'm reading seems to suggest that most buyers are looking to the US government for a Bear Stearns-esque buyout. That was a dangerous precedent to set and I'm not convinced, as some are, that bailing out Bear was absolutely necessary.

I think the best news is that we can tie these bailouts with the Bush Administration and leave them behind come November - if the major players are fine until then, an Obama or McCain Administration can dismiss bailouts as just the policy of a predecessor.

What does everyone think of bank runs as self-fulfilling prophecies? Consumers lose confidence in a bank, which proceeds to fail, but is the biggest cause of failure the loss of consumer confidence? Their circular nature scares me. It also looms ominously over the remaining banks - the market has been unpredictable and I don't think it would take much to scare people and induce another run.

How about inducing a bank run as a form of terrorism? Anyone see that as possible? I'm going to stop before my questions become absolutely ridiculous...


Zachary Piso said...

I'm just curious, because this is certainly outside my realm of knowledge, but are individuals ever recognized as responsible for a bank run? What causes the run? What is the incentive?

Because the only incentive I could see would be from a competing bank hoping to scare off the consumers of its competition. So, if society had enough evidence to indict the competing bank, should it then force that bank to pay the bail out of the other bank? We are still one bank down, just a different one. And if we just punish that bank, either a) the punish isn't severe enough to discourage the inciting of future runs, or b) it's so strong that we are now down two banks.

And I don't want to see the words "McCain" and "administration" in the same sentence again.

Pete Abbate said...

As I understand bank runs, in a traditional bank such as IndyMac Bank in California this summer, it's nearly impossible to pinpoint blame. Responsibility in that specific situation may lie partly with Rep. Charles Schumer for speaking poorly of the bank, but the phenomenon in general seems to be a product of group-think mentality and the realization that if the bank does fail, it will be difficult to get money out.

The FDIC does insure deposits and in the case of IndyMac, anyone who had money there had access to all of it within a matter of a week or two. [I know this from personal experience because I had customers at my summer job with CDs held through IndyMac].

From an individual level, as I tried to say, the incentive is basically to get your money out of the bank before the FDIC takes over, because you would prefer to not have it tied up at all. Runs do not occur on well-capitalized banks because if a bank is in good financial position, it can offer some incentive to attract new customers if a number of old customers leave - a special interest rate to induce deposits, perhaps. Regulators also can calm the public by offering assurances or scanning a company's books.

I have never heard of a scenario where one bank initiates a run on another. It's possible, I suppose, and an indictment of the bank that started the run would be the appropriate response. Generally, though, because bank runs make consumers uneasy about banking in general, and most banks are interwoven with purchases of debt and securities from one another, this would not be a profitable situation for the average bank to undertake.