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Faced with a shortage of liquidity, banks resorted to fire sales of assets, depressing their prices throughout the system and reducing their value as collateral,
Faced with a shortage of liquidity, banks resorted to fire sales of assets, depressing their prices throughout the system and reducing their value as collateral, triggering further sales and price falls. Imagine you receive a bill for which you do not have sufficient funds to pay now. Which of the following strategies might you adopt when faced with your individual liquidity crisis, and why was that strategy not available to banks during the crisis?
a Delay payment: push the bill down the side of the sofa and wait for a reminder. However, if customers demand 'cash', banks cannot ask them to wait. This would cause instant panic and a devastating run on the bank.
b Borrow from a friend, family or bank. However, this may take time to arrange, and a bank does not have time.
c Instead of selling an asset for money, offer the asset or equivalent goods directly to the creditor. Bank creditors, however, are only interested in money.
d Sell one or more assets, making sure you get a fair market price. This will be difficult for a bank since it has to act very quickly. Furthermore, the liquidity problem is likely to be widespread, in which case every bank will be trying to do the same thing. The market price of relevant assets is likely to collapse.
e All the above are correct.
f and are correct
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