64 Pages Posted: 9 Oct 2014 Last revised: 29 Jan 2015
Date Written: June 30, 2014
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. These financial fire sales can both cause, and exacerbate, real fire sales, the focus of previous studies. This paper investigates the relevance of financial fire sales using new datasets covering bank failures during the farm depression in the United States just before the Great Depression, as well as bank failures during the Great Depression. Using differences in regulation 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 distress in nearby banks. All this indicates a rationale for why bank failures are contagious.
Keywords: Bank failures, liquidity, fire sales
JEL Classification: G1, J1, A1
Suggested Citation: Suggested Citation
Rajan, Raghuram G. and Ramcharan, Rodney, Local Financial Capacity and Asset Values: Evidence from Bank Failures (June 30, 2014). Journal of Financial Economics (JFE), Forthcoming; FEDS Working Paper No. 2014-67. Available at SSRN: https://ssrn.com/abstract=2498085 or http://dx.doi.org/10.2139/ssrn.2498085