The world’s financial authorities have rightly been doing whatever it takes to limit the fallout of one of the worst pandemics ever. Central banks — particularly the U.S. Federal Reserve — have devised unprecedented measures and pledged trillions of dollars to support lending. Their efforts have eased panic, stabilized markets and kept at least some money flowing to people and businesses.
Yet this episode, much like the last crisis in 2008, raises a troubling question: Why is the financial system so fragile that, whenever something big and unexpected happens, the world must rely on officials’ heroic efforts to rescue an ever-widening array of markets and institutions?
When the economy gets back on the path to recovery, it’s worth considering whether a more permanent fix is needed.
The system’s vulnerability stems from a defining element of banking. On one side of their balance sheets, banks issue short-term debt such as deposits — promises that people can access their money immediately or on short notice. On the other side, they put most of the money into longer-term investments such as loans. Generally, this works fine: Banks keep enough cash on hand to facilitate their customers’ needs, and their lending helps fuel economic growth. But at any given moment, banks have the cash to pay only a fraction of their depositors. So at the slightest sign of distress, people have a strong incentive to get their money out first — triggering “runs” that can devastate the financial system and the economy.