When the Knickerbocker Trust Company suffered a bank run in October 1907 it led to the 10th banking crisis in the fifty years since the widespread availability of the telegraph.
The panic spawned the Federal Reserve and the era of modern finance as we know it. Last week Bulgaria was forced to act swiftly after a coordinated effort to create panic led to a bank run on Bulgaria’s fourth largest lender. Customer’s reportedly received mysterious text messages urging them to withdraw funds, backed up by false rumours on Facebook and YouTube.
As the Knickerbocker Crisis illustrates, bank runs are nothing new, but are economies more vulnerable now that social media can potentially spread panic so rapidly?
Financial markets are markets in information. From the late 1850s onwards the time to transmit a message from New York to London fell to less than a minute, something that previously had taken three weeks. The telegraph transformed their operation.
Mostly it was positive for economies. It led to a golden age of international finance, funding investments in the basic infrastructure such as railways that fuelled trade and that we still reap the benefits from today.
But it is hard to deny that in that initial period the volatility of economies, and the frequency of banking crises, increased as well.
According to a Bank of England paper, In the industrial nations there were 4 recorded banking panics in the 18th century, compared to 12 in the 19th century and 22 in the 20th century.
The really knotty issue is that perfectly solvent banks, and banking systems, can be undone by a panic. The very nature of banks is to take deposits that are theoretically available to customers on demand, but lend that money in the form of mortgages. If everyone decides they want to withdraw at once, there will always be a problem.
Former Bank of England Governor Mervyn King summed it up well. It is irrational to start a bank run, he said, but rational to join one.
So it would be great to argue, essentially, that there is no smoke without fire, and that there must have been an underlying problem at Bulgaria’s Corporate Commercial Bank for it to need a 3.3 billion lev (£1.4 billion) credit line.
However, in the area of banking crises this is not true. Banks are more like big tinder boxes and every retweet, unwittingly or otherwise, is like lobbing another lighted match onto the pile.
Fortunately central bankers have understood this better than anyone for over a century.
The playbook is simple enough, known as Bagehot’s Dictum: in the face of a gathering crisis lend and lend big, publically. It is a show of confidence – to demonstrate how laughable it is for a few rumours to bring down a nation’s finances.
For otherwise solvent institutions the role of Bank of England as lender of last resort has been effective enough since 1866. Bulgaria’s response was classic Bagehot and as a result we are not talking about the (needless) collapse of an economy.
Maybe in the future the Bank of England should tweet photos of vast piles of gold (or its printing press.) Either way, for central bankers social media is a new front but its battle to keep confidence high is a constant one.