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The Failure Mechanics of Dealer Banks

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  • Darrell Duffie
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    Abstract

    During the recent financial crisis, major dealer banks -- that is, banks that intermediate markets for securities and derivatives -- suffered from new forms of bank runs. The most vivid examples are the 2008 failures of Bear Stearns and Lehman Brothers. Dealer banks are often parts of large complex financial organizations whose failures can damage the economy significantly. As a result, they are sometimes considered "too big to fail." The mechanics by which dealer banks can fail and the policies available to treat the systemic risk of their failures differ markedly from the case of conventional commercial bank runs. These failure mechanics are the focus of this article. This is not a review of the financial crisis of 2007-2009. Systemic risk is considered only in passing. Both the financial crisis and the systemic importance of large dealer banks are nevertheless obvious and important motivations.

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.51
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    Bibliographic Info

    Article provided by American Economic Association in its journal Journal of Economic Perspectives.

    Volume (Year): 24 (2010)
    Issue (Month): 1 (Winter)
    Pages: 51-72

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    Handle: RePEc:aea:jecper:v:24:y:2010:i:1:p:51-72

    Note: DOI: 10.1257/jep.24.1.51
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    1. Elisabeth Ledrut & Christian Upper, 2007. "Changing post-trading arrangements for OTC derivatives," BIS Quarterly Review, Bank for International Settlements, December.
    2. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
    3. Milbourn, Todd T. & Boot, Arnoud W. A. & Thakor, Anjan V., 1999. "Megamergers and expanded scope: Theories of bank size and activity diversity," Journal of Banking & Finance, Elsevier, vol. 23(2-4), pages 195-214, February.
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    Cited by:
    1. Sebnem Kalemli-Ozcan & Bent Sorensen & Sevcan Yesiltas, 2011. "Leverage Across Firms, Banks and Countries," NBER Chapters, in: Global Financial Crisis National Bureau of Economic Research, Inc.
    2. Jimmy Melo, 2014. "Expectativas cambiarias, selección adversa y liquidez," Ensayos Revista de Economia, Universidad Autonoma de Nuevo Leon, Facultad de Economia, vol. 0(1), pages 27-62, May.
    3. Cochrane, John H., 2011. "Understanding policy in the great recession: Some unpleasant fiscal arithmetic," European Economic Review, Elsevier, vol. 55(1), pages 2-30, January.
    4. Upper, Christian, 2011. "Simulation methods to assess the danger of contagion in interbank markets," Journal of Financial Stability, Elsevier, vol. 7(3), pages 111-125, August.
    5. Robert E. Lucas, Jr. & Nancy L. Stokey, 2011. "Liquidity crises," Economic Policy Paper 11-3, Federal Reserve Bank of Minneapolis.
    6. Priyank Gandhi & Hanno Lustig, 2010. "Size Anomalies in U.S. Bank Stock Returns: A Fiscal Explanation," NBER Working Papers 16553, National Bureau of Economic Research, Inc.
    7. Carruthers, Bruce G., 2013. "Diverging derivatives: Law, governance and modern financial markets," Journal of Comparative Economics, Elsevier, vol. 41(2), pages 386-400.
    8. Hubert Janos Kiss & Ismael Rodriguez-Lara & Alfonso Rosa-Garcia, 2013. "Do Social Networks Prevent or Promote Bank Runs?," IEHAS Discussion Papers 1344, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
    9. Chevallier, Julien, 2012. "Global imbalances, cross-market linkages, and the financial crisis : a multivariate Markov-Switching analysis," Economics Papers from University Paris Dauphine 123456789/8773, Paris Dauphine University.
    10. Jan Wrampelmeyer, 2013. "Darrell Duffie: How big banks fail and what to do about it," Financial Markets and Portfolio Management, Springer, vol. 27(2), pages 253-256, June.
    11. Sheri M. Markose, 2012. "Systemic Risk from Global Financial Derivatives," IMF Working Papers 12/282, International Monetary Fund.
    12. Timothy J. Riddiough, 2011. "Can Securitization Work? Economic, Structural and Policy Considerations," Working Papers 242011, Hong Kong Institute for Monetary Research.
    13. David Murphy, 2012. "Maintaining Confidence," FMG Special Papers sp216, Financial Markets Group.
    14. Chan-Lau, Jorge A. & Liu, Estelle X. & Schmittmann, Jochen M., 2013. "Equity returns in the banking sector in the wake of the great recession and the European sovereign debt crisis," Discussion Papers 32/2013, Deutsche Bundesbank, Research Centre.
    15. Oehmke, Martin, 2014. "Liquidating illiquid collateral," Journal of Economic Theory, Elsevier, vol. 149(C), pages 183-210.
    16. Jason Wu, 2013. "Discussion of The Economics of Shadow Banking," RBA Annual Conference Volume, in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.
    17. René M. Stulz, 2014. "Governance, Risk Management, and Risk-Taking in Banks," NBER Working Papers 20274, National Bureau of Economic Research, Inc.

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