Banking Crises - Part 1.

2007 saw the beginning of a financial crisis that was far larger than anything experienced since 1929. The freezing of credit in the inter-bank market and the general lack of action by banks, in terms of loans and investment, had a massive impact on both the financial sector and the wider economy. The relatively upbeat mood in Davos this year hints that we are moving out of the battle of the financial crisis into the long war of economic recovery. Banking crises are, however, not only present in the real economy, but also in virtual economies too.

Second Life players are easily offended when the online experience is referred to as a game, they treat it as a virtual environment. The view taken by Linden Labs, the games creator, is that they provide the software and the hosting servers and the players create the world. In this way the rules Linden Labs lay out are very sparse and the economy operates under a laissez faire approach.

This however has been found to have some undesirable effects, namely, bank runs. The first one occurred with an in-game bank known as Ginko. Suspicion should have been high that the bank was a high-risk entity as it promised 40% returns on deposits per annum. Ginko invested heavily in Second Life casinos, this proved disastrous as Linden Labs banned any and all gambling activities. With no deposit insurance scheme and sequential service being in effect depositors rationally acted following the large losses and withdrew their deposits. Within days Ginko had collapsed with the cost to players estimated at being $750,000.

This event illustrates depositor reaction to a single banks misfortunes, later in the week I’ll take a look at the systematic crisis that soon followed.