PAUL KRUGMAN: It’s a Miserable Life

[kevinmc]

Last week the scene at branches of Countrywide Bank, with crowds of agitated depositors trying to withdraw their money, looked a bit like the bank run in the classic holiday movie “It’s a Wonderful Life.”

As it happens, Countrywide’s customers were overreacting. True, the bank is owned by Countrywide Financial, the nation’s largest mortgage lender — and mortgage lenders are in big trouble these days. But bank deposits up to $100,000 are protected by the Federal Deposit Insurance Corporation. Old-fashioned bank runs just don’t make sense these days.

New-fashioned bank runs, on the other hand, do make sense — and they’re at the heart of the current financial crisis.

The key to understanding what’s happening is taking a broad view of what constitutes a bank. From an economic perspective, a bank is any institution that offers people liquidity — the ability to convert their assets into cash on short notice — while still using their money to make long-term investments.

Traditional banks promise depositors the right to withdraw their funds at any time. Yet banks lend out most of the money depositors place in their care, keeping only a fraction in cash. The reason this works is that normally a bank’s depositors want to withdraw only a small proportion of their money on any given day........

http://freedemocracy.blogspot.com/2007/08/paul-krugman-its-miserable-life.html