To see what this means, first suppose that in period 2 rents are disappointing-25, not 100. Given the structure of our model, in the absence of intermediaries this should have no effect on the price of land at the end of the second period, since it does not change the probability distribution of future rents But a less-than-Panglossian rent in period 2 means that creditors of intermediaries need to be bailed out in that period, and therefore that future creditors can no longer expect the same. So the intermediaries collapse, and the price of land drops from 100 to the expected rent 50 Notice that this means that there is a magnification effect on the losses of the intermediaries established in the first period. The"real"news about the economy is that rents in period 2 were 25, not the hoped-for 100. But land bought for 200 will now yield only 25 in rents plus 50 in resale value, a loss of 125 rather than merely 75. The magnification effect is caused, of course, logic of disintermediation: the prospective end to intermediation, driven by the losses of the existing institutions, reduces asset prices and therefore magnifies those losses And now we come to the possibility of multiple equilibria. Suppose that in fact intermediaries have been lucky, and that second-period rents do turn out to be 100. Now if everyone then expects that the government will continue to guarantee intermediaries in the future, the land price at the end of the second period will also be 100. In that case no bailout will b needed, and so the government guarantee for intermediation will in fact continue But on the other hand, suppose that despite the high rents in the second period potential creditors become convinced that there will be no guarantee on newly incurred liabilities of intermediaries Then they will not be able to attract funds, and the price of land in the second period will be only 50 That means, however, that intermediaries that borrowed money in the first period based on Pangloss values, including the Pangloss value of 100 for land sales, will require a bailout-and since the government's willingness to provide for bailouts is now exhausted, investors' pessimism is justified In short, our stylized little model appears to generate a story about self-fulfilling financial crises, in which plunging asset prices undermine banks, and the collapse of the banks in turn ratifies the drop in asset prices. But it is not the only such story 3. Modeling the crisis II: Disintermediation and liquidition Even as the conventional wisdom has appeared to crystallize around the view that moral hazard and the resulting asset price inflation created the preconditions for the asian crisis, some observers have violently disagreed. Recently Radelet and Sachs (1998) have argued that "The East Asian crisis resulted from vulnerability to financial panic, combined with a series of accidents that triggered the panic. Since we view the crisis as a case of multiple equilibrium, our hypothesis is that the crisis could have been avoided without any dramatic change in fundamentals. In effect, they argue that the pre-crisis asset values were more or less reasonable, and that it is the current deflated values that are an aberration-obviously an important point for assessing fire-sale FDI What kind of model could make sense of this view? The main contender is a"bank run "model along the lines of the classic paper by diamond and Dybvig(1983). Such models, like the moral hazard model, attribute crisis to the collapse of financial intermediaries. However, financial intermediariesTo see what this means, first suppose that in period 2 rents are disappointing - 25, not 100. Given the structure of our model, in the absence of intermediaries this should have no effect on the price of land at the end of the second period, since it does not change the probability distribution of future rents. But a less-than-Panglossian rent in period 2 means that creditors of intermediaries need to be bailed out in that period, and therefore that future creditors can no longer expect the same. So the intermediaries collapse, and the price of land drops from 100 to the expected rent 50. Notice that this means that there is a magnification effect on the losses of the intermediaries established in the first period. The "real" news about the economy is that rents in period 2 were 25, not the hoped-for 100. But land bought for 200 will now yield only 25 in rents plus 50 in resale value, a loss of 125 rather than merely 75. The magnification effect is caused, of course, by the circular logic of disintermediation: the prospective end to intermediation, driven by the losses of the existing institutions, reduces asset prices and therefore magnifies those losses. And now we come to the possibility of multiple equilibria. Suppose that in fact intermediaries have been lucky, and that second-period rents do turn out to be 100. Now if everyone then expects that the government will continue to guarantee intermediaries in the future, the land price at the end of the second period will also be 100. In that case no bailout will be needed; and so the government guarantee for intermediation will in fact continue. But on the other hand, suppose that despite the high rents in the second period potential creditors become convinced that there will be no guarantee on newly incurred liabilities of intermediaries. Then they will not be able to attract funds, and the price of land in the second period will be only 50. That means, however, that intermediaries that borrowed money in the first period based on Pangloss values, including the Pangloss value of 100 for land sales, will require a bailout - and since the government's willingness to provide for bailouts is now exhausted, investors' pessimism is justified. In short, our stylized little model appears to generate a story about self-fulfilling financial crises, in which plunging asset prices undermine banks, and the collapse of the banks in turn ratifies the drop in asset prices. But it is not the only such story. 3. Modeling the crisis II: Disintermediation and liquidiation Even as the conventional wisdom has appeared to crystallize around the view that moral hazard and the resulting asset price inflation created the preconditions for the Asian crisis, some observers have violently disagreed. Recently Radelet and Sachs (1998) have argued that "The East Asian crisis resulted from vulnerability to financial panic, combined with a series of accidents that triggered the panic. Since we view the crisis as a case of multiple equilibrium, our hypothesis is that the crisis could have been avoided without any dramatic change in fundamentals." In effect, they argue that the pre-crisis asset values were more or less reasonable, and that it is the current deflated values that are an aberration - obviously an important point for assessing fire-sale FDI. What kind of model could make sense of this view? The main contender is a "bank run" model along the lines of the classic paper by Diamond and Dybvig (1983). Such models, like the moral hazard model, attribute crisis to the collapse of financial intermediaries. However, financial intermediaries