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Government intervention in response to the subprime financial crisis: The good into the pot, the bad into the crop

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  • Breitenfellner, Bastian
  • Wagner, Niklas

Abstract

The subprime-related 2007/2008 global financial crisis represented a major economic challenge. In order to prevent such episodes of market failure, it is vital to understand what caused the crisis and which lessons are to be learned. Given the tremendous bailout packages worldwide, we discuss the role of governments as lenders of last resort. In our view, it is important not to suspend the market mechanism of bankruptcy via granting rescue packages. Only those institutions which are illiquid but solvent should be rescued, and this should occur at a significant cost for the respective institution. We provide a formal illustration of a rescue mechanism, which allows to distinguish between illiquid but solvent and insolvent banks. Furthermore, we argue that stricter regulation cannot be the sole consequence of the crisis. There appears to be a need for improved risk awareness, more sophisticated risk management and a better alignment of interests among the participants in the market for credit risk.

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Bibliographic Info

Article provided by Elsevier in its journal International Review of Financial Analysis.

Volume (Year): 19 (2010)
Issue (Month): 4 (September)
Pages: 289-297

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Handle: RePEc:eee:finana:v:19:y:2010:i:4:p:289-297

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Web page: http://www.elsevier.com/locate/inca/620166

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Keywords: Financial crisis Government intervention Bailout Risk management Credit derivatives Securitization;

References

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  1. Marvin Goodfriend & Robert G. King, 1988. "Financial deregulation, monetary policy, and central banking," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 3-22.
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Citations

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Cited by:
  1. Simona-Gabriela MAŞCA & Viorela Ligia VĂIDEAN & Andreea GOLGUŢ, 2011. "The State and the Economy – Theoretical Aspects and Empirical Evidence for the EU," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(5(558)), pages 17-44, May.
  2. Alsakka, Rasha & ap Gwilym, Owain, 2012. "Rating agencies' credit signals: An analysis of sovereign watch and outlook," International Review of Financial Analysis, Elsevier, vol. 21(C), pages 45-55.
  3. Claudio Morana, 2013. "Factor Vector Autoregressive Estimation of Heteroskedastic Persistent and Non Persistent Processes Subject to Structural Breaks: New Insights on the US OIS SPreads Term Structure," Working Papers 233, University of Milano-Bicocca, Department of Economics, revised Feb 2013.
  4. Chang, Chuen-Ping, 2012. "Default probability of a captive credit bank with government capital injections: A capped barrier option approach," Economic Modelling, Elsevier, vol. 29(6), pages 2444-2450.
  5. Chang, Chuen-Ping, 2014. "A barrier option framework for rescue package designs and bank default risks," Economic Modelling, Elsevier, vol. 38(C), pages 246-257.
  6. Nathalie Rey, 2012. "États et Systèmes financiers européens : une relation biaisée," Post-Print halshs-00697323, HAL.
  7. Jacques, Sébastien & Lai, Van Son & Soumaré, Issouf, 2011. "Synthetizing a debt guarantee: Super-replication versus utility approach," International Review of Financial Analysis, Elsevier, vol. 20(1), pages 27-40, January.
  8. Nathalie Rey, 2012. "European States and Financial Systems: A Biased Relationship," Post-Print halshs-00758892, HAL.
  9. Ntim, Collins G. & Lindop, Sarah & Thomas, Dennis A., 2013. "Corporate governance and risk reporting in South Africa: A study of corporate risk disclosures in the pre- and post-2007/2008 global financial crisis periods," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 363-383.
  10. Lin, Jyh-Horng & Tsai, Jeng-Yan & Hung, Wei-Ming, 2014. "Bank equity risk under bailout programs of loan guarantee and/or equity capital injection," International Review of Economics & Finance, Elsevier, vol. 31(C), pages 263-274.

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