TY  - JOUR
AU  - Diamond,Douglas W.
AU  - Rajan,Raghuram G.
TI  - Fear of Fire Sales and the Credit Freeze
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14925
PY  - 2009
Y2  - April 2009
UR  - http://www.nber.org/papers/w14925
L1  - http://www.nber.org/papers/w14925.pdf
N1  - Author contact info:
Douglas W. Diamond
Booth School of Business
University of Chicago
5807 S Woodlawn Avenue
Chicago, IL 60637
Tel: 773/702-7283
Fax: 773/834-9134
E-Mail: douglas.diamond@chicagobooth.edu

Raghuram Rajan
Booth School of Business
University of Chicago
5807 South Woodlawn Avenue
Chicago, IL 60637
Tel: 773/702-4437
Fax: 773/702-0458
E-Mail: raghuram.rajan@ChicagoBooth.edu
AB  - Is there any need to “clean” up a banking system in the midst of a crisis, by closing or recapitalizing weak banks and taking bad assets off bank balance sheets, or can one wait till the crisis is over? We argue that an “overhang” of impaired banks that may be forced to sell assets soon can reduce the current price of illiquid assets sufficiently that weak banks have no interest in selling them. Anticipating a potential future fire sale, cash rich buyers have high expected returns to holding cash, which also reduces their incentive to lock up money in term loans. The potential for a worse fire sale than necessary, as well as the associated decline in credit origination, could make the crisis worse, which is one reason it may make sense to clean up the system even in the midst of the crisis. We discuss alternative ways of cleaning up the system, and the associated costs and benefits.
ER  -