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Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts

  • Farhi, Emmanuel
  • Tirole, Jean

The paper elicits a mechanism by which private leverage choices exhibit strategic complementarities through the reaction of monetary policy. When everyone engages in maturity transformation, authorities haver little choice but facilitating refinancing. In turn, refusing to adopt a risky balance sheet lowers the return on equity. The key ingredient is that monetary policy is non-targeted. The ex post benefits from a monetary bailout accrue in proportion to the number amount of leverage, while the distortion costs are to a large extent fixed. This insight has important consequences. First, banks choose to correlate their risk exposures. Second, private borrowers may deliberately choose to increase their interest-rate sensitivity following bad news about future needs for liquidity. Third, optimal monetary policy is time inconsistent. Fourth, macro-prudential supervision is called for. We characterize the optimal regulation, which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets. We establish the robustness of our insights when the set of bailout instruments is endogenous and characterize the structure of optimal bailouts.

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File URL: http://www.tse-fr.eu/sites/default/files/medias/doc/wp/ng/wp_nogroup_52_2009.pdf
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Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 09-052.

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Length: 49 pages
Date of creation: Jun 2009
Date of revision: Oct 2010
Publication status: Published in American Economic Review, vol. 102, février 2012, p. 60-93.
Handle: RePEc:tse:wpaper:21951
Contact details of provider: Phone: (+33) 5 61 12 86 23
Web page: http://www.tse-fr.eu/

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  1. Romain Ranciere & Aaron Tornell & Frank Westermann, 2005. "Systemic Crises and Growth," NBER Working Papers 11076, National Bureau of Economic Research, Inc.
  2. Farhi, Emmanuel & Tirole, Jean, 2009. "Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts," TSE Working Papers 09-052, Toulouse School of Economics (TSE), revised Oct 2010.
  3. Bengt Holmstrom & Jean Tirole, 1997. "Financial Intermediation, Loanable Funds, and The Real Sector," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 663-691.
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  6. Viral Acharya & Tanju Yorulmazer, 2007. "Too many to fail - an analysis of time-inconsistency in bank closure policies," Bank of England working papers 319, Bank of England.
  7. Viral Acharya & Tanju Yorulmazer, 2007. "Cash-in-the-market pricing and optimal resolution of bank failures," Bank of England working papers 328, Bank of England.
  8. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  9. Huberto M. Ennis & Todd Keister, 2009. "Bank Runs and Institutions: The Perils of Intervention," American Economic Review, American Economic Association, vol. 99(4), pages 1588-1607, September.
  10. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  11. Ennis, Huberto M. & Keister, Todd, 2010. "Banking panics and policy responses," Journal of Monetary Economics, Elsevier, vol. 57(4), pages 404-419, May.
  12. Cooper,Russell, 1999. "Coordination Games," Cambridge Books, Cambridge University Press, number 9780521578967, June.
  13. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  14. Douglas W. Diamond & Raghuram G. Rajan, 2009. "Illiquidity and Interest Rate Policy," NBER Working Papers 15197, National Bureau of Economic Research, Inc.
  15. V. V. Chari & Patrick J. Kehoe, 2013. "Bailouts, time inconsistency, and optimal regulation," Staff Report 481, Federal Reserve Bank of Minneapolis.
  16. Martin Schneider & Aaron Tornell, 2004. "Balance Sheet Effects, Bailout Guarantees and Financial Crises," Review of Economic Studies, Oxford University Press, vol. 71(3), pages 883-913.
  17. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
  18. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  19. Thomas Philippon & Philipp Schnabl, 2009. "Efficient Recapitalization," NBER Working Papers 14929, National Bureau of Economic Research, Inc.
  20. Cooper,Russell, 1999. "Coordination Games," Cambridge Books, Cambridge University Press, number 9780521570176, June.
  21. Mailath George J. & Mester Loretta J., 1994. "A Positive Analysis of Bank Closure," Journal of Financial Intermediation, Elsevier, vol. 3(3), pages 272-299, June.
  22. Holmström, Bengt, 2011. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262015783.
  23. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," NBER Working Papers 5146, National Bureau of Economic Research, Inc.
  24. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
  25. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  26. Kashyap, Anil K. & Rajan, Raghuram G. & Stein, Jeremy C., 2008. "Rethinking capital regulation," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 431-471.
  27. Ernesto Pastén, 2011. "Time - Consistent Bailout Plans," Working Papers Central Bank of Chile 635, Central Bank of Chile.
  28. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
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