Causes, Consequences and Implications for Reform
Edited by Lawrence E. Mitchell and Arthur E. Wilmarth, Jr
Chapter 7: Lessons from 2008 US Bank Failures
William C. Handorf* Although bank crises commonly occur every 10 to 15 years in some region of the world, the underlying asset classes and countries responsible for such crises shift. The current global banking catastrophe has largely arisen out of unsafe residential real estate lending in the United States and toxic collateralized debt obligations backed by very high-risk classes embedded within mortgage-backed securities. Governmental leaders in many countries have taken unprecedented steps to minimize further disruptions to their financial markets and economies by increasing deposit insurance levels, guaranteeing short-term and long-term debt previously issued by financial institutions, and investing in preferred stock of selected banks whose survival is deemed important. Bank failure is not a new phenomenon and it is not costless. Countries from all continents have previously incurred significant fiscal costs to bail out unsuccessful banks and recapitalize or nationalize salvageable institutions. If banks are unable to intermediate funds from surplus savings sectors to worthwhile deficit borrowing sectors, economic problems escalate within a country because consumers and businesses are unable to finance the production or consumption of durable goods, working capital or plant and equipment. The consequences of a failing banking system can also be severe when banks finance a sizable portion of governmental debt. A credit freeze precipitates dire economic problems for the remaining fragile financial institutions. This chapter briefly reviews bank risk within the context of the ever-increasing number of bank failures within the US and identifies preliminary lessons for a more thorough study that clearly will...
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