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The disposition of failed bank assets: put guarantees or loss-sharing arrangements?

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  • Mark M. Spiegel

Abstract

To mitigate the regulator losses associated with bank failures, efforts are usually made to dispose of failed bank assets quickly. However, this process usually precludes due diligence examination by acquiring banks, leading to problems of asymmetric information concerning asset quality. this paper examines two mechanisms that have been used for dealing with these problems, "put guarantees," under which acquiring banks are allowed to return assets to the regulatory authority for liquidation, and "loss-sharing arrangements," under which the acquiring banks keep all assets under their control to maturity and are then compensated by the regulatory authority for a portion of asset losses. The analysis is conducted in a Hart-Moore framework in which the removal of certain assets from the banking system can reduce their value. Changes in the relative desirability of the two guarantee mechanisms during economic downturns are shown to depend on the credibility of the regulatory authority. When the regulatory authority enjoys credibility, a downturn favors the loss-sharing arrangement, while when the regulatory authority lacks credibility, the impact of a downturn is ambiguous.

Suggested Citation

  • Mark M. Spiegel, 2001. "The disposition of failed bank assets: put guarantees or loss-sharing arrangements?," Working Paper Series 2001-12, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2001-12
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    File URL: http://www.frbsf.org/economic-research/files/wp01-12bk.pdf
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    1. Stover, Roger D., 1997. "Early resolution of troubled financial institutions: An examination of the accelerated resolution program," Journal of Banking & Finance, Elsevier, vol. 21(8), pages 1179-1194, August.
    2. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, Oxford University Press, vol. 113(1), pages 1-41.
    3. Baibirer, Sheldon D. & Jud, G. Donald & Lindahl, Frederick W., 1992. "Regulation, competition, and abnormal returns in the market for failed thrifts," Journal of Financial Economics, Elsevier, vol. 31(1), pages 107-131.
    4. Gupta, Atul & LeCompte, Richard L. B. & Misra, Lalatendu, 1997. "Taxpayer subsidies in failed thrift resolution: The impact of FIRREA," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 327-339, July.
    5. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-1242, September.
    6. Nikhil Varaiya & David Ely, 1997. "Assessing the Resolution of Insolvent Thrift Institutions post FIRREA: The Impact of Resolution Delays," Journal of Financial Services Research, Springer;Western Finance Association, vol. 11(3), pages 255-282, June.
    7. Eric S. Rosengren & Katerina Simons, 1994. "Failed Bank Resolution and the Collateral Crunch: The Advantages of Adopting Transferable Puts," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 22(1), pages 135-147.
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    Cited by:

    1. Andrew Kuritzkes & Til Schuermann & Scott Weiner, 2002. "Deposit Insurance and Risk Management of the U.S. Banking System: How Much? How Safe? Who Pays?," Center for Financial Institutions Working Papers 02-02, Wharton School Center for Financial Institutions, University of Pennsylvania.
    2. Cowan, Arnold R. & Salotti, Valentina, 2015. "The resolution of failed banks during the crisis: Acquirer performance and FDIC guarantees, 2008–2013," Journal of Banking & Finance, Elsevier, vol. 54(C), pages 222-238.

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    Keywords

    Bank failures ; Bank assets;

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