Calomiris on “Contagious Events”

As we minute by minute are inching closer to the announcement of some form of restructuring/write-down of Greek Sovereign debt nervous investors focus on the risk of contagion from the Greek crisis to other European economies and contagion in the European banking sector.

In a paper from 2007 Charles Calomiris has a good and interesting discussion of what he calls “Contagious events”.

Here is the abstract:

“Bank failures during banking crises, in theory, can result either from unwarranted depositor withdrawals during events characterized by contagion or panic, or as the result of fundamental bank insolvency. Various views of contagion are described and compared to historical evidence from banking crises, with special emphasis on the U.S. experience during and prior to the Great Depression. Panics or “contagion” played a small role in bank failure, during or before the Great Depression-era distress. Ironically, the government safety net, which was designed to forestall the (overestimated) risks of contagion, seems to have become the primary source of systemic instability in banking in the current era.”

WARNING: If you are looking for a justification for bailouts you will probably not find it in this paper, but you will find some interesting “advise” on banking regulation.

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  1. Only tangentially connected, but this post indicates how much we down here in Downunder are in such a different world regarding public debt and budget balances than Japan, the US, Eurozone and the UK.

    I have some concerns about our housing markets (prices have way overshot rents), but not that some sort of wider collapse is likely.

  2. Lorenzo, you have nothing to worry about – yes, housing prices might have peaked and might even drop quite a bit and yes growth might begin to soften, but Australia has monetary policy flexibility and if growth where to slow markedly then the RBA has all the ammunition in the world. The Aussie dollar has already corrected quite a bit and that is clearly helping. This is the difference between “gold standard” monetary policy as we have in Europe and floating exchange rates. My guess is that Australia will keep on outperforming growthwise even if commodity prices where to collapse. That said, I would not like to be long Aussie dollars…but AUD weakness is exactly what will soften the blow.

  3. Ryan Sanchez

     /  October 28, 2011

    Hello Mr. Christensen,

    Thank you for the link to the paper it was one of the most interesting things I have read in a while, particularly this passage:

    Bank distress is associated not only with bank failures, but with general macroeconomic consequences resulting from the reduced supply of loans and deposits, which can amplify business cycle downturns and spread panic-induced financial distress from banks to the whole economy (Ben Bernanke 1983, Charles Calomiris and Joseph Mason 2003b).

    It appears that this passage goes a long way in understanding Bernanke’s interpretation of the recession, that if he could provide liquidity and continue to be the lender of last resort for banks that would allow for a stop to the contraction in the credit markets, stopping the overall contraction of NGDP.

    The other striking point was about depositor insurance and its roll in enhancing risk, I was wondering if you had any thoughts about what effects removing government backed deposit insurance might have today in the States.

    Also, aside from making points about the regulation of banks, the paper did not draw any conclusions about monetary policy, what insights might the fundamentalist view of bank runs might be drawn to better conduct monetary policy in the future.

    Thanks very much for your blog, my friends are slowly coming around to the idea of an NGDP target.

    Best regards


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