IDEAS home Printed from https://ideas.repec.org/a/fip/a00068/96624.html
   My bibliography  Save this article

So Far, So Good: Government Insurance of Financial Sector Tail Risk

Author

Listed:
  • Larry D. Wall

Abstract

The US government has intervened to provide extraordinary support 16 times from 1970 to 2020 with the goal of preventing or mitigating (or both) the cost of financial instability to the financial sector and the real economy. This article discusses the motivation for such support, reviewing the instances where support was provided, along with one case where it was expected but not provided. The article then discusses the moral hazard and fiscal risks posed by the government's insurance of the tail risk along with ways to reduce the government's risk exposure.

Suggested Citation

  • Larry D. Wall, 2021. "So Far, So Good: Government Insurance of Financial Sector Tail Risk," Policy Hub, Federal Reserve Bank of Atlanta, vol. 2021(13), November.
    • Handle: RePEc:fip:a00068:96624
    DOI: 10.29338/ph2021-13
    as

    Download full text from publisher

    File URL: https://www.atlantafed.org/-/media/documents/research/publications/policy-hub/2021/11/08/13--government-insurance-of-financial-sector-tail-risk.pdf
    Download Restriction: no
    File URL: https://libkey.io/10.29338/ph2021-13?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
    2. Wall, Larry D. & Peterson, David R., 1990. "The effect of Continental Illinois' failure on the financial performance of other banks," Journal of Monetary Economics, Elsevier, vol. 26(1), pages 77-99, August.
    3. Ricardo J. Caballero & Takeo Hoshi & Anil K. Kashyap, 2008. "Zombie Lending and Depressed Restructuring in Japan," American Economic Review, American Economic Association, vol. 98(5), pages 1943-1977, December.
    4. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
    5. Antonio Falato & Itay Goldstein & Ali Hortaçsu, 2020. "Financial Fragility in the COVID-19 Crisis: The Case of Investment Funds in Corporate Bond Markets," Working Papers 2020-98, Becker Friedman Institute for Research In Economics.
    6. Falato, Antonio & Goldstein, Itay & Hortaçsu, Ali, 2021. "Financial fragility in the COVID-19 crisis: The case of investment funds in corporate bond markets," Journal of Monetary Economics, Elsevier, vol. 123(C), pages 35-52.
    7. Stephen G. Cecchetti, 2009. "Crisis and Responses: The Federal Reserve in the Early Stages of the Financial Crisis," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 51-75, Winter.
    8. Gary Gorton & Ellis W. Tallman, 2016. "Too Big to Fail before the Fed," American Economic Review, American Economic Association, vol. 106(5), pages 528-532, May.
    9. Egemen Eren & Andreas Schrimpf & Vladyslav Sushko, 2020. "US dollar funding markets during the Covid-19 crisis - the international dimension," BIS Bulletins 15, Bank for International Settlements.
    10. Hannes Schwandt & Till von Wachter, 2019. "Unlucky Cohorts: Estimating the Long-Term Effects of Entering the Labor Market in a Recession in Large Cross-Sectional Data Sets," Journal of Labor Economics, University of Chicago Press, vol. 37(S1), pages 161-198.
    11. Adam Ashcraft & Morten L. Bech & W. Scott Frame, 2010. "The Federal Home Loan Bank System: The Lender of Next-to-Last Resort?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(4), pages 551-583, June.
    12. Ryan Banerjee & Boris Hofmann, 2022. "Corporate zombies: anatomy and life cycle," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 37(112), pages 757-803.
    13. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    14. Lisa J. Dettling & Lauren Lambie-Hanson, 2021. "Why is the Default Rate So Low? How Economic Conditions and Public Policies Have Shaped Mortgage and Auto Delinquencies During the COVID-19 Pandemic," FEDS Notes 2021-03-04-2, Board of Governors of the Federal Reserve System (U.S.).
    15. Andrew F. Haughwout & Benjamin Hyman & Matthew Lieber, 2020. "Helping State and Local Governments Stay Liquid," Liberty Street Economics 20200410b, Federal Reserve Bank of New York.
    16. Michael D Bordo & Owen F Humpage & Anna J Schwartz, 2015. "The Evolution of the Federal Reserve Swap Lines since 1962," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 63(2), pages 353-372, September.
    17. Frederic S. Mishkin, 2011. "Over the Cliff: From the Subprime to the Global Financial Crisis," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 49-70, Winter.
    18. Deborah Lucas, 2019. "Measuring the Cost of Bailouts," Annual Review of Financial Economics, Annual Reviews, vol. 11(1), pages 85-108, December.
    19. Demirgüç-Kunt, Asli & Huizinga, Harry, 2013. "Are banks too big to fail or too big to save? International evidence from equity prices and CDS spreads," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 875-894.
    20. James A. Clouse, 1994. "Recent developments in discount window policy," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Nov, pages 965-977.
    21. Andrew J. Jalil, 2015. "A New History of Banking Panics in the United States, 1825-1929: Construction and Implications," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(3), pages 295-330, July.
    22. Michael J. Fleming, 2020. "Treasury Market Liquidity and the Federal Reserve during the COVID-19 Pandemic," Liberty Street Economics 20200529a, Federal Reserve Bank of New York.
    23. Linda S. Goldberg & Craig Kennedy & Jason Miu, 2011. "Central bank dollar swap lines and overseas dollar funding costs," Economic Policy Review, Federal Reserve Bank of New York, vol. 17(May), pages 3-20.
    24. Michael T. Belongia & R. Alton Gilbert, 1990. "The Effects of Management Decisions on Agricultural Bank Failures," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 72(4), pages 901-910.
    25. Kuklinski, James H. & West, Darrell M., 1981. "Economic Expectations and Voting Behavior in United States House and Senate Elections," American Political Science Review, Cambridge University Press, vol. 75(2), pages 436-447, June.
    26. Jappelli, Ruggero & Pelizzon, Loriana & Plazzi, Alberto, 2021. "The core, the periphery, and the disaster: Corporate-sovereign nexus in COVID-19 times," SAFE Working Paper Series 331, Leibniz Institute for Financial Research SAFE.
    27. Herman, Alexander & Igan, Deniz & Solé, Juan, 2017. "The macroeconomic relevance of bank and nonbank credit: An exploration of U.S. data," Journal of Financial Stability, Elsevier, vol. 32(C), pages 124-141.
    28. Carmen M. Reinhart, 2019. "Financial crises: past and future," Business Economics, Palgrave Macmillan;National Association for Business Economics, vol. 54(1), pages 3-15, January.
    29. Sumit Agarwal & Jacqueline Barrett & Mariacristina De Nardi, 2011. "The asset-backed securities markets, the crisis, and TALF," Profitwise, Federal Reserve Bank of Chicago, issue Apr, pages 8-18.
    30. Ben Bemanke & Harold James, 1991. "The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison," NBER Chapters, in: Financial Markets and Financial Crises, pages 33-68, National Bureau of Economic Research, Inc.
    31. Liang, J., 2020. "Designing the Main Street Lending Program: Challenges and Options," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 2(3), pages 1-40, April.
    32. Franklin R. Edward, 1999. "Hedge Funds and the Collapse of Long-Term Capital Management," Journal of Economic Perspectives, American Economic Association, vol. 13(2), pages 189-210, Spring.
    33. William A. Allen & Richhild Moessner, 2013. "The Liquidity Consequences of the Euro Area Sovereign Debt Crisis," World Economics, World Economics, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 14(1), pages 103-126, January.
    34. Nina Boyarchenko & Richard K. Crump & Anna Kovner & Or Shachar & Peter Van Tassel, 2020. "The Primary and Secondary Market Corporate Credit Facilities," Liberty Street Economics 20200526a, Federal Reserve Bank of New York.
    35. Joseph G. Haubrich, 2007. "Some lessons on the rescue of Long-Term Capital Management," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Apr.
    36. Sachs, J.D., 1989. "New Approaches To The Latin American Debt Crisis," Princeton Studies in International Economics 174, International Economics Section, Departement of Economics Princeton University,.
    37. Philip Oreopoulos & Till von Wachter & Andrew Heisz, 2012. "The Short- and Long-Term Career Effects of Graduating in a Recession," American Economic Journal: Applied Economics, American Economic Association, vol. 4(1), pages 1-29, January.
    38. repec:cto:journl:v:21:y:2002:i:3:p:369-393 is not listed on IDEAS
    39. Viral V Acharya & Sascha Steffen, 2020. "The Risk of Being a Fallen Angel and the Corporate Dash for Cash in the Midst of COVID," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 9(3), pages 430-471.
    40. Allen, Franklin & Carletti, Elena, 2013. "New theories to underpin financial reform," Journal of Financial Stability, Elsevier, vol. 9(2), pages 242-249.
    41. Edward J. Kane, 1987. "DANGERS OF CAPITAL FORBEARANCE: THE CASE OF THE FSLIC AND “ZOMBIE” S&Ls," Contemporary Economic Policy, Western Economic Association International, vol. 5(1), pages 77-83, January.
    42. Edward J. Stevens, 2003. "The new discount window," Economic Commentary, Federal Reserve Bank of Cleveland, issue May.
    43. Kenneth E. Scott, 2012. "A Guide to the Resolution of Failed Financial Institutions - Dodd-Frank II and Proposed Chapter 14," Book Chapters, in: Kenneth E. Scott & John B. Taylor (ed.), Bankruptcy Not Bailout, chapter 1, Hoover Institution, Stanford University.
    44. Brimmer, Andrew F, 1989. "Distinguished Lecture on Economics in Government: Central Banking and Systemic Risks in Capital Markets," Journal of Economic Perspectives, American Economic Association, vol. 3(2), pages 3-16, Spring.
    45. Martin Feldstein, 1991. "The Risk of Economic Crisis," NBER Books, National Bureau of Economic Research, Inc, number feld91-2, March.
    46. Tri Vi Dang & Gary B. Gorton & Bengt R. Holmstrom, 2019. "The Information View of Financial Crises," NBER Working Papers 26074, National Bureau of Economic Research, Inc.
    47. Philip R. Lane, 2012. "The European Sovereign Debt Crisis," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 49-68, Summer.
    48. W. Scott Frame, 2009. "The 2008 federal intervention to stabilize Fannie Mae and Freddie Mac," FRB Atlanta Working Paper 2009-13, Federal Reserve Bank of Atlanta.
    49. Moessner, Richhild & Allen, William A., 2013. "Central bank swap line effectiveness during the euro area sovereign debt crisis," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 167-178.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. repec:fip:a00001:94154 is not listed on IDEAS
    2. Arnold, Grace E. & Rhodes, Meredith E., 2021. "Information sensitivity of corporate bonds: Evidence from the COVID-19 crisis," Finance Research Letters, Elsevier, vol. 42(C).
    3. Frederic S. Mishkin & Eugene White, 2014. "Unprecedented actions: the Federal Reserve’s response to the global financial crisis in historical perspective," Globalization Institute Working Papers 209, Federal Reserve Bank of Dallas.
    4. Mathias S. Kruttli & Phillip J. Monin & Lubomir Petrasek & Sumudu W. Watugala, 2021. "Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis," Finance and Economics Discussion Series 2021-038, Board of Governors of the Federal Reserve System (U.S.).
    5. Forbes, Kristin & Friedrich, Christian & Reinhardt, Dennis, 2023. "Stress relief? Funding structures and resilience to the covid shock," Journal of Monetary Economics, Elsevier, vol. 137(C), pages 47-81.
    6. De Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic risk: A survey," Working Paper Series 35, European Central Bank.
    7. Kaboski, Joseph & Huneeus, Federico & Larrain, Mauricio & Schmukler, Sergio & Vera, Mario, 2022. "The Distribution of Crisis Credit: Effects on Firm Indebtedness and Aggregate Risk," CEPR Discussion Papers 17061, C.E.P.R. Discussion Papers.
    8. Andrieș, Alin Marius & Ongena, Steven & Sprincean, Nicu, 2021. "The COVID-19 Pandemic and Sovereign Bond Risk," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    9. John H. Boyd & Mark Gertler, 1993. "US Commercial Banking: Trends, Cycles, and Policy," NBER Chapters, in: NBER Macroeconomics Annual 1993, Volume 8, pages 319-377, National Bureau of Economic Research, Inc.
    10. Gary Gorton & Lixin Huang, 2004. "Liquidity, Efficiency, and Bank Bailouts," American Economic Review, American Economic Association, vol. 94(3), pages 455-483, June.
    11. Thomas M. Eisenbach & Gregory Phelan, 2022. "Fragility of Safe Asset Markets," Staff Reports 1026, Federal Reserve Bank of New York.
    12. Gopalakrishnan, Balagopal & Jacob, Joshy & Mohapatra, Sanket, 2022. "COVID-19 pandemic and debt financing by firms: Unravelling the channels," Economic Modelling, Elsevier, vol. 114(C).
    13. Viral V Acharya & Ryan Niladri & Matteo Crosignani & Tim Eisert & Renée Spigt, 2022. "Exorbitant privilege? Quantitative easing and the bond market subsidy of prospective fallen angels," BIS Working Papers 1002, Bank for International Settlements.
    14. Mahyar Kargar & Benjamin Lester & David Lindsay & Shuo Liu & Pierre-Olivier Weill & Diego Zúñiga, 2021. "Corporate Bond Liquidity during the COVID-19 Crisis [The day coronavirus nearly broke the financial markets]," The Review of Financial Studies, Society for Financial Studies, vol. 34(11), pages 5352-5401.
    15. Anne-Laure Delatte & Julien Fouquau & Richard Portes, 2014. "Nonlinearities in sovereign risk pricing the role of cds index contracts," SciencePo Working papers Main hal-03460263, HAL.
    16. Ferrando, Annalisa & Popov, Alexander & Udell, Gregory F., 2017. "Sovereign stress and SMEs’ access to finance: Evidence from the ECB's SAFE survey," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 65-80.
    17. Koenig, Philipp J. & Pothier, David, 2022. "Safe but fragile: Information acquisition, liquidity support and redemption runs," Journal of Financial Intermediation, Elsevier, vol. 52(C).
    18. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    19. Mitchener, Kris & Trebesch, Christoph, 2021. "Sovereign Debt in the 21st Century: Looking Backward, Looking Forward," CEPR Discussion Papers 15935, C.E.P.R. Discussion Papers.
    20. Michael D. Bordo & Bruce Mizrach & Anna J. Schwartz, 1998. "Real versus Pseudo-International Systemic Risk Some Lessons from History," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 1(01), pages 31-58.
    21. repec:hal:spmain:info:hdl:2441/6b3bdv9unt9mspi3ri2ff917d6 is not listed on IDEAS
    22. Jiang, Hao & Li, Yi & Sun, Zheng & Wang, Ashley, 2022. "Does mutual fund illiquidity introduce fragility into asset prices? Evidence from the corporate bond market," Journal of Financial Economics, Elsevier, vol. 143(1), pages 277-302.

    More about this item

    Keywords

    financial stability; FDIC; Federal Reserve; Treasury; bailout; financial history;
    All these keywords.

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management
    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:a00068:96624. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Robert Sarwark (email available below). General contact details of provider: https://edirc.repec.org/data/frbatus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.