Fire Sales: An Overview “The term “fire sale” has been around since the nineteenth century to describe firms selling smoke-damaged goods at cut rate prices in the aftermath of a fire” (Shleifer 2011). In the fields of economics and finance, “fire sale” has been adopted to describe the distressed sales of assets at prices well below their true value.
This deviation of asset price is a key amplifier during financial crisis and often acts as a contagion, spreading illiquidity problems to firms in similar industries (Caballero 2009). In the 2008 crisis, large losses for a bank would force this bank to sell assets at distressed prices. This process would force other banks to re-value the same assets at a lower price and would cause them to sell these assets and prices below fundamental value, incurring losses (French 2010). “Compared to non-bank, bank failure contagion [as a result of distressed sales] appears faster; is more likely to spread to a larger proportion of the industry; is likely to lead to a larger percentage of failures, and is more likely to spill over to other sectors”(Kaufman 1994). Fire sales typically occur in a single firm and then the decreased liquidity cascades to other firms in the same industry. In the case of financial institutions, fire sales often spread to other sectors of the economy as well.
Fire sales can be thought of as positive feedback loops; financial distress forces firms to sell assets, which causes the prices of these assets to depreciate. This process leads to increased financial distress (Shleifer 2011). In this way, fire sales can depreciate asset prices and decrease economy-wide liquidity to the point of having a significant negative effect on an economy.
Macroeconomic Effects
The literature discussing the negative macroeconomic effects of fire sales is numerous. Many of these papers quote negative impacts to be