Abstract
In a January 2009 lecture on the financial crisis, Federal Reserve Chairman Bernanke advocated a new Fed policy of credit easing, defined as a combination of lending to financial institutions, providing liquidity directly to key credit markets, and buying of long term securities. We show that Bernanke's analysis and recommendations can be naturally considered in a model of unstable banking, which relies on two mechanisms: 1) fire sales reduce asset prices below fundamental values, and 2) financial institutions prefer speculation to new lending when markets are dislocated. We analyze credit easing and compare it to alternative government interventions during the crisis.
Highlights
The model of unstable banking focuses on what Gary B
Fully realize that sentiment regarding the securities they hold on their balance sheets may shift in the future, forcing them to liquidate their security holdings just as their competitors do the same, a phenomenon known as fire sales (Shleifer and Vishny 1992)
Securitization is too profitable for banks to hold back, and they expand their balance sheets and leverage to the maximum that capital markets would allow, accepting the risk of fire sales
Summary
Vishny Working Paper 15652 http://www.nber.org/papers/w15652 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138. Asset Fire Sales and Credit Easing Andrei Shleifer and Robert W. Vishny NBER Working Paper No 15652 January 2010 JEL No E51,E58,G21
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