Financial Crises’ Optimization

This paper is about events where one or more banks face difficulty ruling over their short-term liabilities and perhaps fail. it is natural to think of these events as occurring where some agents have some benefits from creating the risk of these kinds of events, and perhaps do not bear all the societal costs. it is natural to think of these as inefficient outcomes, such as a straightforward way of thinking about that is coming from implicit bank guarantees, for example. What is surprising is that they may happen. This article is about challenging this view. The goal is to try to persuade the reader that there may be some, not just private values but judiciary values to set up a financial system that is subject to these kinds of events where multiple banks will fail at the same time and face difficulty ruling over their debt. In that sense, this article is not trying to convince someone that financial crises may have some efficiency problems. So, it leads very naturally to the question that has been studied already. And this article is going to try to contribute to the understanding of why individual banks per se find an optimal to finance themselves in a fragile way where they are subject to these inefficient terminations. And more generally, why might there be an optimal to have a system that is subject to these kinds of shocks? it is that kind of a question that is under discussion here in this article.