Contagion: Bank runs and COVID-19
Stephen G. Cecchetti and Kermit L. SchoenholtzThe key to US authorities’ credibility in the midst of the financial crisis was that, even
after making large capital injections in late 2008, they still had the means to bail out a
failing institution. As a result, investors accepted the news that the stress-tested banks
‘only’ needed to add $75 billion in equity funding, allowing newly confident private
markets to recapitalise them for the first time since Lehman’s failure.
To limit the economic fallout from a pandemic, the requirement of thorough and credible
disclosure is the same. Even if people believe that almost everyone is healthy, there is
an incentive to stay away from places where you may encounter someone carrying
the illness. Daily news of transmission in dozens of countries leads to the obvious
conclusion that infection can happen anywhere. And, just as it is costly to observe the
health of a bank in a crisis, in a pandemic it is difficult or impossible to observe whether
someone sitting next to you is carrying (and spreading) the disease. Every cough and
sniffle trigger fear.
The lesson from the 2009 stress tests is that sound science and public health policy
are critical to limiting economically destabilising behaviour. For people to regain the
confidence needed to go about their normal daily business, governments will need to
demonstrate some combination of (1) credible testing to demonstrate the population
is nearly virus free, (2) the effective quarantine of those stricken, and (3) advances in
treatment that limit the pathogen’s impact.
Success requires that people view authorities as extraordinarily trustworthy. This means
providing detailed, up-to-date information on the spread of the illness, its severity and
the methods available for treatment and control. As John Barry argues (see the opening
quote), they have to stick to the facts, and shun politics entirely. Any attempt to colour
the facts weakens the credibility of the announcements and delays the point at which
confidence returns.
References
Barry, J M (2004), The Great Influenza: The Epic Story of the Deadliest Plague in
History, Penguin Books.
Board of Governors of the Federal Reserve System (2009), “The Supervisory Capital
Assessment Program: Overview of Results”, 7 May.
Cecchetti, S G and K L Schoenholtz (2020), “Bank Runs and Panics: A Primer”, http://www.
moneyandbanking.com, 2 March.