Financial Fire Sales: Evidence from Bank Failures

58 Pages Posted: 31 May 2017

See all articles by Rodney Ramcharan

Rodney Ramcharan

University of Southern California, Marshall School of Business

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Date Written: 2014-06-30

Abstract

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

Suggested Citation

Ramcharan, Rodney and Rajan, Raghuram G., Financial Fire Sales: Evidence from Bank Failures (2014-06-30). FEDS Working Paper No. 2014-67. Available at SSRN: https://ssrn.com/abstract=2976975

Rodney Ramcharan (Contact Author)

University of Southern California, Marshall School of Business ( email )

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HOME PAGE: http://https://sites.google.com/site/rodneyramcharan/

Raghuram G. Rajan

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States
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International Monetary Fund (IMF) ( email )

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National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States
773-702-9299 (Phone)
773-702-0458 (Fax)

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