Bank Failures in Theory and History: The Great Depression and Other "Contagious" Events
Bank failures during banking crises, in theory, can result either from unwarranted depositor withdrawals during events characterized by contagion or panic, or as the result of fundamental bank insolvency. Various views of contagion are described and compared to historical evidence from banking crises, with special emphasis on the U.S. experience during and prior to the Great Depression. Panics or "contagion" played a small role in bank failure, during or before the Great Depression-era distress. Ironically, the government safety net, which was designed to forestall the (overestimated) risks of contagion, seems to have become the primary source of systemic instability in banking in the current era.
This paper was prepared for the Oxford Handbook of Banking, edited by Allen Berger, Phil Molyneux, and John Wilson. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.