Paradise lost | Economist.com
For nine months now, banks have been in a panic: hoarding cash, nervous of weaknesses in their own balance-sheets and even more nervous of their counterparties. More damaging still, money-market funds have steered clear of banks as well. The drying-up of liquidity not only created havoc in the backrooms of the financial system. It also wrecked the front door, thanks to the dramatic collapse of Bear Stearns, an 85-year-old Wall Street investment bank that was bought for a song by JPMorgan Chase in March. The Federal Reserve offered emergency funding to the investment banks for the first time since the 1930s, and there were bank bail-outs in Britain and Germany too.
The economic effects are set to be just as striking. According to a study of previous crises by Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard, banking blow-outs lop an average of two percentage points off output growth per person. The worst crises reduce growth by five percentage points from their peak, and it takes more than three years for growth to regain pre-crisis levels.