But there is reason to suspect that, under free banking, panics would be unlikely even without deposit guarantees. As Gary Gorton has shown in several articles (Gorton 1985a, 1985c; Gorton and Mullineaux 1985), in a market where bank liabilities are competitively bought and sold there would not be any risk-information externality. Note and deposit exchange rates would reflect potentials for capital losses depending on the soundness of underlying bank loans and investments. Chapter R showed how note brokerage systematically eliminates note-discount- Ing except when it is based on risk-default generally acknowledged by professional note dealers, including banks themselves. In short, note brokerage produces information on bank-specific foe With such information available to depositors, no information externality could cause bank runs to spread indiscriminantly through a banking system. After confirming through the newspaper that there is no discount on the notes he holds, a bank customer would feel no urge to redeem them in a hurry. Gorton also points out that, even though no distinct secondary (arbitrage) market exists for the risk-pricing of deposit liabilities,25 so long as notes and deposits of any one bank are backed by the same asset portfolio (as would be the case under free banking) the existence of a secondary note market provides depositors with all the information required to prevent them from staging a redemption run.

Thus under free banking no risk-information externality problem would arise. This may explain why failure of individual banks never precipitated general runs either in the Scottish free banking system or in Canada during the period when its banks engaged in relatively unregulated note issue. oid