Repo runs

The recent financial crisis saw bank runs of a new kind. Instead of depositors running banks, banks were running each other. I do not think anybody had foreseen that such a thing could happen, and there was little theory to help policy. Now we have at least two.

One is by Harald Uhlig. The second is by Antoine Martin, David Skeie and Ernst-Ludwig von Thadden. In both cases, it is about maturity mismatches, a core issue in bank runs: banks invest in longer maturities than their liabilities. In this case, banks hold assets as guarantees, but they have difficulties selling them quickly when in need of liquidity. Of course, if this happens at more than one bank, this has also an impact on asset prices, thus making it even more difficult to raise the required liquidity. The first paper emphasizes that risk aversion is crucial here to explain the discounts on the assets. The second paper highlights how cash-in-the-market pricing can precipitate a run. In both cases, it makes sense for a governmental authority to buy those assets at prices above market, and in both cases the government should be able to make a profit from this operation. Let's whether this will be the case in reality.