Darrell Duffie


On his book How Big Banks Fail and What to Do about It

Cover Interview of July 27, 2011

A close-up

The book’s story line carries, I hope, some dramatic interest.  And it demands relatively little background knowledge.  A reader whose curiosity is piqued will hopefully go further and cover the supporting concepts and institutional knowledge in the remaining chapters.

Start with the opening of Chapter 1.  A few pages here take the reader through the death throes of a large bank that is an active intermediary in markets for securities, derivatives, and overnight borrowing. The bank is losing its battle to maintain liquidity. The bank’s shareholders and managers cannot be easily convinced to raise new capital.  Its counterparties, clients, and creditors are deserting it, one after another. They are in an effective run, racing each other to extract the cash that remains at the failing bank.  The bank supplies cash to them readily, at first, in an attempt to signal its strength.  To do otherwise would only heighten fears and accelerate the run.  In the end, however, our protagonist bank cannot turn its illiquid assets into cash quickly enough to survive.

This bank is a fictional but realistic composite of Bear Stearns, Lehman Brothers, and Morgan Stanley.  Morgan Stanley did not ultimately fail.  It had a viable business and substantial assets—but its dramatic loss of liquidity threatened its collapse in the days following the October-2008 failure of Leman Brothers.  I believe that Morgan Stanley would have indeed failed but for the dramatic provision of liquidity to it by the Federal Reserve Bank of New York.