Financing Capacity and Fire Sales: Evidence from Bank Failures
Raghuram G. Rajan
University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)
University of Southern California, Price School of Public Policy
November 18, 2013
Theory suggests the reduction in financing capacity after the failure of a financial intermediary can reduce the value of financial assets. Forced sales of the intermediary’s assets could consume liquidity, depressing the liquidation value of the assets of healthy intermediaries and causing contagious runs. This paper investigates these predictions using a new dataset of bank failures during the farm depression just before the Great Depression. Using regulatory impediments to lending across state borders as a means of identification, we find that the reduction in local financing capacity as a result of bank failures reduces the recovery rates on failed assets of nearby banks, depresses local land prices, renders land markets illiquid, and is associated with subsequent financial sector distress among nearby banks. All this indicates a rationale for why bank failures are contagious.
Number of Pages in PDF File: 44
Date posted: November 19, 2013