The 2008 crisis spread because banks’ liquidity depends on others’ willingness to stay illiquid

Evidence

In sum, a web of mispriced risks, with the price set at zero, between the “normal” banking system and the shadow banking system was created through the unseen links between mortgage bonds and CDSs that amplified the grossly underestimated existing correlation between assets. A problem that began in the repo market in 2007 was no longer confined there. The crisis spread globally as investors sought the protection of liquidity but failed to find it. Just as one country’s exports depends upon another country’s imports, so one bank’s liquidity depends upon another bank’s willingness to be illiquid. And at that moment, no one wanted to be illiquid. — Mark Blyth, Austerity, 98

Categorization

• XREF: This systemic liquidity interdependence connects to the concept of herding and coordination failure in financial stability literature, and to Minsky’s financial instability hypothesis. — connects to: Falling collateral values triggered Bear Stearns’ liquidity crisis. — Mark Blyth, Austerity: The History of a Dangerous…, 83; High bank leverage turns small asset declines into instant illiquidity and insolvency. — Mark Blyth, Austerity: The History of a Dangerous…, 84; Fire-sale contagion, not state spending, drove the 2008 liquidity collapse. — Mark Blyth, Austerity: The History of a Dangerous…, 85 (+2 more)

Broader Connections

• Housing price declines triggered the 2008 financial crisis #qualifies (0.80) — Nick Srnicek, Platform Capitalism, 31
• Packing risky mortgages into opaque derivatives under weak regulation enabled the financial crisis #expands (0.78) — Albert Bandura, Moral Disengagement, 1492