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Fire Sales in Finance and Macroeconomics

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  • Andrei Shleifer
  • Robert Vishny

Abstract

Analysts of the recent financial crisis often refer to the role of asset "fire sales" in depleting the balance sheets of financial institutions and aggravating the fragility of the financial system. The term "fire sale" has been around since the nineteenth century to describe firms selling smoke-damaged merchandise at cut-rate prices in the aftermath of a fire. But what are fire sales in broad financial markets with hundreds of participants? As we suggested in a 1992 paper, a fire sale is essentially a forced sale of an asset at a dislocated price. The asset sale is forced in the sense that the seller cannot pay creditors without selling assets. The price is dislocated because the highest potential bidders are typically involved in a similar activity as the seller, and are therefore themselves indebted and cannot borrow more to buy the asset. Indeed, rather than bidding for the asset, they might be selling similar assets themselves. Assets are then bought by nonspecialists who, knowing that they have less expertise with the assets in question, are only willing to buy at valuations that are much lower. In this paper, we selectively review some of the research on fire sales, emphasizing both concepts and supporting evidence. We begin by describing our 1992 model of fire sales and the related findings in empirical corporate finance. We then show that models of fire sales can account for several related phenomena during the recent financial crisis, including the contraction of the banking system and the failures of arbitrage in financial markets exemplified by historically unprecedented differences in prices of very similar securities. We then link fire sales to macroeconomics by discussing how such dislocations of security prices and the reduction in balance sheets of banks can reduce investment and output. Finally, we consider how the concept of fire sales can help us think about government interventions in financial markets, including the evidently successful Federal Reserve interventions in 2009. Fire sales are surely not the whole story of the financial crisis, but they are a phenomenon that binds together many elements of the crisis.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.29
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Bibliographic Info

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

Volume (Year): 25 (2011)
Issue (Month): 1 (Winter)
Pages: 29-48

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Handle: RePEc:aea:jecper:v:25:y:2011:i:1:p:29-48

Note: DOI: 10.1257/jep.25.1.29
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References

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  1. Efraim Benmelech & Nittai K. Bergman, 2008. "Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines," NBER Working Papers 14059, National Bureau of Economic Research, Inc.
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  6. Coval, Joshua & Stafford, Erik, 2007. "Asset fire sales (and purchases) in equity markets," Journal of Financial Economics, Elsevier, vol. 86(2), pages 479-512, November.
  7. Tobias Adrian & Hyun Song Shin, 2010. "The changing nature of financial intermediation and the financial crisis of 2007-09," Staff Reports 439, Federal Reserve Bank of New York.
  8. Benmelech, Efraim & Bergman, Nittai K., 2009. "Collateral pricing," Journal of Financial Economics, Elsevier, vol. 91(3), pages 339-360, March.
  9. Guido Lorenzoni, 2008. "Inefficient Credit Booms," Review of Economic Studies, Wiley Blackwell, vol. 75(3), pages 809-833, 07.
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Citations

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Cited by:
  1. Raddatz, Claudio & Schmukler, Sergio L., 2012. "On the international transmission of shocks: Micro-evidence from mutual fund portfolios," Journal of International Economics, Elsevier, vol. 88(2), pages 357-374.
  2. Greenwood, Robin & Landier, Augustin & Thesmar, David, 2011. "Vulnerable Banks," TSE Working Papers 11-280, Toulouse School of Economics (TSE).
  3. Casselmann, Farina, 2013. "Financial services regulation in the wake of the crisis: The Capital Requirements Directive IV and the Capital Requirements Regulation," IPE Working Papers 18/2013, Berlin School of Economics and Law, Institute for International Political Economy (IPE).
  4. Itai Agur, 2011. "Bank Risk within and across Equilibria," DNB Working Papers 305, Netherlands Central Bank, Research Department.
  5. Boeckx, J., 2012. "What is the role played by the Eurosystem during the financial crisis ?," Economic Review, National Bank of Belgium, issue II, pages 7-28, September.
  6. Peter Koudijs & Joachim Voth, 2011. "Optimal delay: Distressed trading in 18th c. Amsterdam," Economics Working Papers 1343, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Lensberg, Terje & Schenk-Hoppé, Klaus Reiner & Ladley, Dan, 2012. "Costs and Benefits of Speculation," Discussion Papers 2012/12, Department of Finance and Management Science, Norwegian School of Economics.
  8. Selcuk, Cemil, 2012. "Distressed sales and liquidity in OTC markets," MPRA Paper 38188, University Library of Munich, Germany.
  9. Charles A. E. Goodhart & Anil K Kashyap & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2013. "An Integrated Framework for Analyzing Multiple Financial Regulations In this companion paper to Goodhart et al. (2012), we explore the interactions of various types of financial regulation. We find th," International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 109-144, January.
  10. Rodney Ramcharan & Skander Van den Heuvel & Stephane Verani, 2013. "From Wall Street to main street: the impact of the financial crisis on consumer credit supply," Finance and Economics Discussion Series 2013-10, Board of Governors of the Federal Reserve System (U.S.).

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