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Forbearance, subordinated debt, and the cost of capital for insured depository institutions

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  • William P. Osterberg
  • James B. Thomson

Abstract

Using an explicit model for subordinated debt that considers the possibility of FDIC forbearances, the authors show that forbearance 1) alters the required rate of return on subordinated debt while increasing its market value and 2) weakens the effectiveness of such debt as a source of market discipline.

Suggested Citation

  • William P. Osterberg & James B. Thomson, 1992. "Forbearance, subordinated debt, and the cost of capital for insured depository institutions," Economic Review, Federal Reserve Bank of Cleveland, vol. 28(Q III), pages 16-26.
    • Handle: RePEc:fip:fedcer:y:1992:i:qiii:p:16-26:n:v.28no.3
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    References listed on IDEAS

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    1. Herbert L. Baer, 1985. "Private prices, public insurance: The pricing of federal deposit insurance," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 9(Sep), pages 45-57.
    2. Gorton, Gary & Santomero, Anthony M, 1990. "Market Discipline and Bank Subordinated Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(1), pages 119-128, February.
    3. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
    4. Flannery, Mark J., 1991. "Pricing deposit insurance when the insurer measures bank risk with error," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 975-998, September.
    5. Avery, Robert B & Belton, Terrence M & Goldberg, Michael A, 1988. "Market Discipline in Regulating Bank Risk: New Evidence from the Capital Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(4), pages 597-610, November.
    6. Edward J. Kane, 1985. "The Gathering Crisis in Federal Deposit Insurance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262611856, April.
    7. Pennacchi, George G., 1987. "Alternative forms of deposit insurance : Pricing and bank incentive issues," Journal of Banking & Finance, Elsevier, vol. 11(2), pages 291-312, June.
    8. Richard E. Randall, 1989. "Can the market evaluate asset quality exposure in banks?," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 3-24.
    9. James B. Thomson, 1987. "FSLIC forbearances to stockholders and the value of savings and loan shares," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 26-35.
    10. Chen, Andrew H, 1978. "Recent Developments in the Cost of Debt Capital," Journal of Finance, American Finance Association, vol. 33(3), pages 863-877, June.
    11. Buser, Stephen A & Chen, Andrew H & Kane, Edward J, 1981. "Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital," Journal of Finance, American Finance Association, vol. 36(1), pages 51-60, March.
    12. Hannan, Timothy H & Hanweck, Gerald A, 1988. "Bank Insolvency Risk and the Market for Large Certificates of Deposit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(2), pages 203-211, May.
    13. R. Alton Gilbert, 1990. "Market discipline of bank risk: theory and evidence," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 3-18.
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