Fear of Fire Sales and the Credit Freeze

Douglas W. Diamond and Raghuram G. Rajan

No 14925, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In early 2009, the supply of credit in industrial countries appeared to decline. Could this be because bank balance sheets were “clogged” with illiquid securities? If so, why did banks not attempt to sell them? We argue that an “overhang” of impaired banks that may be forced to sell soon can reduce the current price of illiquid securities sufficiently that banks have no interest in selling. This creates high expected returns to holding cash for potential buyers and an aversion to making term loans. We discuss the implications for policies to clean up the banking system during a financial crisis.

JEL-codes: E44 G01 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-mac
Date: 2009-04
Note: CF EFG IFM ME
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