The tools that modern central banks possess to address liquidity problems can only directly address such runs inside the traditional banking sector, and do not directly touch the non-bank financial sector, which has been hardest hit by the current credit crisis.
James Hamilton, a professor at the University of California, warned that – as in old-fashioned bank runs – sudden demand for liquidity can lead to a firesale of assets that depresses their price, making otherwise solvent institutions insolvent.
Paul McCulley, managing director of Pimco, said there was a “run on the shadow banking system”.
