[belorn]

Talking about currencies and banks, a core aspect is that debt is also a form of currency that be created and destroyed. The biggest issue in modern financial crises is not that banks run out of liquidity, but rather that the trust of existing debt can crash to the point of making people believe that the bank can no longer recover enough of it. A central bank can then act as last resort and buy the debt or repaying debt, restoring trust.

[littlestymaar]

> The biggest issue in modern financial crises is not that banks run out of liquidity, but rather that the trust of existing debt can crash to the point of making people believe that the bank can no longer recover enough of it.

This is exactly what we mean when talking about banks running out of liquidity though.

[belorn]

The financial crisis from 2007-2008 would not have been prevented if banks had more liquidity. Debt insurance help, but that just moves the problem to the insurer.

Subprime mortgages, toxic assets, and excessive risk-taking is about trust and risk. When the government becomes the debt insurance, then that risk get managed through stricter banking regulations. Liquidity do not make a bad debt less bad. At best it can hide the problem as the bank tanks the loss, but that only works as long the bank is profitable.

An other interesting example was the Icelandic financial crisis, where the Sovereign debt defaulted on loans from UK and Netherlands. This caused diplomatic problems, including threats of cutting of the Icelandic banks from the global banking network. The value of the Icelandic currency sharply dropped in relation to other currencies, and the Central Bank of Iceland became unable to act as a lender of last resort. The solution in the end was a international bailout support program, including securing more debt from other nations to pay existing debt. This renewed trust in the sovereign debt, but also the trust in the currency and the government.

[JumpCrisscross]

The biggest problems in modern finance are not about banks running out of liquidity. It hasn’t been since the Great Depression. The recurring problem has been non-banks being bank-like.

[littlestymaar]

It is the biggest problem, until Central Banks intervene and solve the problem altogether, which makes the problem functionally disappear, but it's still the key problem. That's true for any company btw: you can live practically forever insolvent as long as you are liquid, but no matter how solvent you are “liquidity kills you quick”.

[JumpCrisscross]

> until Central Banks intervene and solve the problem altogether, which makes the problem functionally disappear, but it's still the key problem

The Fed and FDIC are separate. Central banks help with the liquidity problem. Deposit insurance solves it.

It remains a core risk. But risks have to be managed. Problems are unsolved.

[littlestymaar]

> The Fed and FDIC are separate. Central banks help with the liquidity problem. Deposit insurance solves it.

It seems you are somehow conflating “liquidity issues” with “what happens with customer's bank account”, as if bank runs were the only kind of liquidity issue that could happen to a bank, and then arguing that this isn't the case. But that's not my point in the first place!

Commercial banks need to borrow (central bank) money every once in a while to meet their liquidity needs, there doesn't need to be a bank run for that to happen, and if at that time nobody wants to lend, they are dead. Fortunately they can get the liquidity they need from the central bank directly at the discount rate, and we don't have a financial crisis every other year like what happened just before the Fed was created.

[JumpCrisscross]

> there doesn't need to be a bank run for that to happen, and if at that time nobody wants to lend, they are dead

Yes. This is what we have been discussing. This is solved.

What you describe happened a year ago. If the bank isn’t insolvent—if it’s just a liquidity issue—that is a solved problem with deposit insurance in America. We fold it, put it into receivership, everyone keeps banking, next day is stressful for accountants. Even without the central bank’s involvement.