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Tuesday, March 18, 2008

The current financial crisis: a crowded theater, a fire...

Paul Krugman has the most cogent and understandable assessment of the country's financial crisis on his blog. Today he upped the ante on clear explanations with this excellent metaphor about two kinds of bank runs:

In some cases, the bank run is a pure self-fulfilling prophecy: the bank is “fundamentally sound,” but a panic by depositors forces a too-hasty liquidation of its assets, and it goes bust. It’s as if someone calls “fire!” in a crowded theater, provoking a stampede that kills many people, even though there wasn’t actually a fire.

In other cases, the bank is fundamentally unsound — but the bank run magnifies its losses. It’s as if someone calls “Fire!” in a crowded theater, and there really is a fire — but the stampede kills people who would have survived an orderly evacuation.

We’re in the second case. The Fed has spent the last 7 months trying to assure people that there isn’t any fire. But there is.

Worse yet, thanks to decades of deregulation, the theater doesn’t have a sprinkler system - and the town the theater is in doesn’t have a fire department.

And if you're a Republican, we can't do anything because raising taxes to build a fire department would hurt business....

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