Discuss the following quote by Gary Gorton (2010, 16-17) from Slapped by the Invisible Hand: The Panic of 2007.
"Uninsured bank debt is vulnerable to panic …[t]he panic starting in August 2007 involved firms withdrawing from other firms by increasing repo haircuts. [A] banking panic occurs when information-insensitive debt becomes information sensitive due to a shock, in this case, the shock to subprime mortgage values due to house prices falling."
Explain why financial institutions, including security firms, and particularly depository institutions, need to be concerned about holdings of uninsured short-term debt. Give an example associated with the U.S. Subprime Loan Crisis or the following Great Recession for global financial institutions.

Question

Discuss the following quote by Gary Gorton (2010, 16-17) from Slapped by the Invisible Hand: The Panic of 2007. 
"Uninsured bank debt is vulnerable to panic …[t]he panic starting in August 2007 involved firms withdrawing from other firms by increasing repo haircuts. [A] banking panic occurs when information-insensitive debt becomes information sensitive due to a shock, in this case, the shock to subprime mortgage values due to house prices falling."
Explain why financial institutions, including security firms, and particularly depository institutions, need to be concerned about holdings of uninsured short-term debt. Give an example associated with the U.S. Subprime Loan Crisis or the following Great Recession for global financial institutions.

Quizplus · Accepted Answer

The Answer is Financial institutions by their nature often have short-term liabilities that must be rolled over when they mature, so if there is bad news about a financial institution or there is a disruption in short-term liability markets or a sharp rise in interest rates for short-term debt, then a financial institution can face a liquidity crisis. Depository institutions are particularly vulnerable to volatile (uninsured large deposits) leaving the bank if other banks offer higher interest rates or if there is bad news about the bank or a contagion effect (uncertainty about the quality of other individual banks with a large bank failure). There are many examples during the U.S. Subprime Loan Crisis, including Bear Stearns and Lehman Brothers, as security firms that depended on short-term financing with repurchase agreements, which with a shortage of collateral for large short-term repo financing used mortgage securities as a source of collateral. With the collapse of the MBS market with huge defaults on subprime loans and mortgage backed securities, the value of mortgage backed securities fell and they became unmarketable, resulting in a liquidity crisis, and firms having an inability to roll over short-term borrowings. Similarly, with large bank failures there were contagion effects with uninsured deposits and other short-term liability holders withdrawing funds from failing banks, as well as other banks, with a loss of confidence in the banking system, and difficulties determining which banks were having problems and which were safe.

Discuss the Following Quote by Gary Gorton (2010, 16-17) from Slapped