8%? There's no way the rates would be that low if you required your 10 year mortgage to be entirely backed by 10 year bonds. I do agree that house prices would necessarily fall, but the new point on the price/demand curve would see both lower prices and lower levels of home ownership. Much worse would be the effects on businesses that could no longer secure debt funding.
It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs.
Rather than a race-condition, a better way to look at it is as an unstable equilibrium. The bank isn't assuming it can keep your deposit for any length of time; instead, it's assuming that in aggregate over all its depositors a certain amount of money will be left on deposit at any given time. Obviously this assumption goes out the window if the depositors act together to remove their deposits - as long as they don't, the system is in equilibrium (it's not rational to withdraw your deposit and forego the interest). As soon as the equilibrium is disturbed and a run starts though, the risk increases sharply and it becomes rational to withdraw your deposit. Government-backed deposit insurance stabilises the equilibrium.
> It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs.
How is this possible? If the bank has to keep 100% of its deposits in reserve, how can it lend at any longer term than the deposits are borrowed for?
You're right, this is not possible. What caf may have been thinking of is that banks may borrow money subject to other conditions, such as by emitting bonds, to which the 100% reserve requirement doesn't apply.
Of course, such a system is also subject to bank runs, just via a different mechanism ("run on bonds" by lenders refusing to roll the bonds over instead of run on deposits).
It's got nothing to do with the fractional reserve system, by the way - a 100% reserve bank still borrows short and lends long and still is subject to bank runs.
Rather than a race-condition, a better way to look at it is as an unstable equilibrium. The bank isn't assuming it can keep your deposit for any length of time; instead, it's assuming that in aggregate over all its depositors a certain amount of money will be left on deposit at any given time. Obviously this assumption goes out the window if the depositors act together to remove their deposits - as long as they don't, the system is in equilibrium (it's not rational to withdraw your deposit and forego the interest). As soon as the equilibrium is disturbed and a run starts though, the risk increases sharply and it becomes rational to withdraw your deposit. Government-backed deposit insurance stabilises the equilibrium.