Misunderstanding Financial Crises

Gary Gorton argues that the 2007 and 2008 crisis was a bank run, that it was the same kind of event as the panics of the nineteenth century, and that economists failed to see it coming because they had stopped studying banking panics. His explanation for that failure is that the United States went from 1934 to 2007 without one, a period he calls the Quiet Period, during which the profession concluded that panics were a solved problem.

The analytical core concerns what he calls information-insensitive debt. Bank deposits, and their modern equivalents in repurchase agreements and asset-backed commercial paper, work as money because nobody needs to investigate their value. Once holders begin to doubt, they must investigate, and the debt stops functioning as money. A run is what happens when short-term debt becomes information-sensitive: holders withdraw or demand more collateral, not because they know the assets are bad but because they no longer know they are good. Gorton argues the 2007 event was a run on repo and on asset-backed commercial paper by institutional investors, structurally identical to depositors queuing at a bank.

His policy implication is that regulation should aim to keep short-term debt information-insensitive rather than to increase transparency, which he argues can precipitate runs rather than prevent them. That conclusion is contested, since it points toward guarantees and away from disclosure. Critics also argue that Gorton underweights the underlying deterioration in mortgage credit quality and treats the run as if its trigger were arbitrary. The book is short, non-technical, and the clearest statement of the run interpretation of the crisis.