Lending Booms, Smart Bankers, and Financial Crises
American Economic Review
vol. 105,
no. 5, May 2015
(pp. 305-09)
Abstract
This paper develops a theory that explains why financial crises follow profitable lending booms. When agents exhibit the "availability heuristic" and there is a long period of banking profitability, all agents—banks, their investors, and regulators—end up in an "availability cascade," overestimating bankers' risk-management skills and underestimating the probability that observed outcomes are due to good luck. Consequently, banks profitably invest in riskier assets. Subsequently, if a public signal reveals that outcomes are luck-driven, investors withdraw funds, liquidity evaporates, and a crisis ensues. A loan resale market improves liquidity but increases the probability of a crisis.Citation
Thakor, Anjan. 2015. "Lending Booms, Smart Bankers, and Financial Crises." American Economic Review, 105 (5): 305-09. DOI: 10.1257/aer.p20151090Additional Materials
JEL Classification
- E32 Business Fluctuations; Cycles
- E44 Financial Markets and the Macroeconomy
- G01 Financial Crises
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages
- G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- L25 Firm Performance: Size, Diversification, and Scope