Banks and Governments, Happily Ever After October 7, 2011 Anna Gelpern American University Washington College of Law
Overview Bank-Government Marriage I. A. Bailouts B. Financial Repression C. Regulatory Nexus D. Cross-Border Dimension II. Pros and Cons III. What Is to Be Done? A. Divorce B. Bankruptcy and Resolution C. Tiering and Contingent Instruments
Overview Bank-Government Marriage I. A. Bailouts B. Financial Repression C. Regulatory Nexus D. Cross-Border Dimension II. Pros and Cons III. What Is to Be Done? A. Divorce B. Bankruptcy and Resolution C. Tiering and Contingent Instruments
I.A. “Bailouts”: Bank Debt Government Problem (Ireland) Sources: Financial Times, Baglioni & Cherubini (2010)
I.A. Bailouts: Problems Fiscal Cost ( but see Rogoff & Reinhart 2009) Moral Hazard, Distortion Accountability
I.B. Financial Repression in Crisis: Government Debt Bank Problem (Portugal) 30000 25000 ECB Purchases? 20000 15000 10000 5000 0 Q1 2009Q2 2009Q3 2009Q4 2009Q1 2010Q2 2010Q3 2010Q4 2010Q1 2011 Source: Banco de Portugal
I.B. Financial Repression (Shaw 1973, McKinnon 1973 … Reinhart et al. 2011a, b, c) Methods Problems Capital Controls Low Growth Reserve Requirements and Moral Hazard, Distortion Prudential Regulation Transparency/ Interest Rate Ceilings Accountability Directed Lending … to Government Taxation Inflation
I.B. Financial Repression as State of Being Source: Financial Times and Japanese MoF
I.A+B. Bailouts+Repression = Marriage Banks save governments (Portugal, Japan) Banks sink governments (Ireland, Iceland) Governments save banks … then sink them (Ireland) Governments sink banks … then save them (Argentina) Secular? … Cyclical? … Structural? ( Cf. Alessandri & Haldane 2009, Reinhart et al. 2011)
I.C. Bank-Government Regulatory Nexus LOLR Deposit Insurance Ex-post Guarantees Dodd-Frank Act, Sec. 619 (Volcker Rule): Recapitalization Notwithstanding the restrictions under subsection (a), … the following activities … are permitted: (A) The Solvency Regulation (Capital) purchase, sale, acquisition, or disposition of obligations Other Prudential Regulation (eg, Concentration Limits, of the United States or any agency thereof … Affiliate Transactions) Liquidity and Collateral Eligibility Business Conduct Regulation Reserve Requirements
I.D. Regulatory Nexus: Cross-Border Dimension Assets Liabilities and Capital Cash 5 Deposits 82 Own Gov’t Bonds 10 Commercial Paper 25 Loans, Private Sector 100 Common Stock 8 TOTAL: 115 TOTAL: 115
I.D. Cross-Border Implications: Greek Government Debt in EU Banks Source: EBA 2011
I.D. Cross-Border Dimension: Third World Debt (1982) 130.1% Source: William R. Cline (1995)
II. Marriage Pros and Cons Pros Cons Risk-Free, Information- Distortion Insensitive Asset … Moral Hazard Mutual Safety Net Delay (if solvency) Financial Stability (if More Losses liquidity) Transparency Accountability Distribution
III. What Is to be Done? Divorce : Separate Banks from Governments, No-Bailout Promises Ex Post: Financial Resolution and Sovereign Bankruptcy Ex Ante: Tiering and Contingent Instruments
III. Tiering and Contingent Instruments Purposes: Transparency Reflect true bank-government relationship Mitigate distortion Force recapitalization/debt restructuring Limit moral hazard Risk/loss distribution Domestic Cross-border (home-host fighting) Preserve stabilizing function
III. Tiering and Contingent Instruments Asset side Formal priority/hierarchy of reserve assets …limited collateral eligibility …limited risk-free treatment for CAR purposes International Reserve Asset? Liability side “Dormant CoCo” – automatic regulatory recapitalization “College” capital – pre-committed recap pool for internationally active banks Based on assets + deposit liabilities (Home + host commitment) Objections: … credibility?
Banks and Governments, Happily Ever After … or “George and Martha—sad, sad, sad…” Source: Warner Bros
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