Banks and Governments, Happily Ever After October 7, 2011 Anna - PowerPoint PPT Presentation

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