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Debt overhang and bank bailouts

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  • Linus Wilson
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    Abstract

    When a bank is deemed 'too big to fail' by regulators, it may be tempted to buy risky assets. This paper analyses bank bailouts involving the purchases of toxic assets, preferred stock and common stock when the government wants to encourage efficient lending. It finds that preferred stock recapitalisations are the least efficient in correcting debt overhang problems from both an ex post and ex ante perspective. In contrast, efficient lending and voluntary participation can be best achieved without subsidy by purchasing either toxic assets or common stock. Nevertheless, troubled banks must be subsidised if they will voluntarily participate in any recapitalisation.

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    Bibliographic Info

    Article provided by Inderscience Enterprises Ltd in its journal Int. J. of Monetary Economics and Finance.

    Volume (Year): 5 (2012)
    Issue (Month): 4 ()
    Pages: 395-414

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    Handle: RePEc:ids:ijmefi:v:5:y:2012:i:4:p:395-414

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    Web page: http://www.inderscience.com/browse/index.php?journalID=218

    Related research

    Keywords: bank bailouts; banking; debt overhang; common stock; capital assistance program; capital purchase program; Emergency Economic Stabilization Act; lending; preferred stock; PPIP; public-private investment partnerships; TARP; too big to fail; toxic assets; efficient lending; voluntary participation; recapitalisation.;

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    Cited by:
    1. Bulow, Jeremy I. & Klemperer, Paul, 2013. "Market-Based Bank Capital Regulation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9618, C.E.P.R. Discussion Papers.

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