Lending Booms, Smart Bankers, and Financial Crises

Anjan Thakor ()

American Economic Review, 2015, vol. 105, issue 5, 305-09

Abstract: This paper develops a theory that explains why financial crises follow profitable lending booms. When agents exhibit the "availability heuristic" and there is a long period of banking profitability, all agents—banks, their investors, and regulators—end up in an "availability cascade," overestimating bankers' risk-management skills and underestimating the probability that observed outcomes are due to good luck. Consequently, banks profitably invest in riskier assets. Subsequently, if a public signal reveals that outcomes are luck-driven, investors withdraw funds, liquidity evaporates, and a crisis ensues. A loan resale market improves liquidity but increases the probability of a crisis.

JEL-codes: E32 E44 G01 G21 G32 L25 (search for similar items in EconPapers)
Date: 2015
Note: DOI: 10.1257/aer.p20151090
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Citations: View citations in EconPapers (25)

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