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While we’re celebrating successful bailouts I suppose it’s worth looking at this VoxEU post and related paper from two Swiss economists about the Fed’s Term Auction Facility, which provided short-term secured funding to U.S. banks who might otherwise have trouble getting such funding between December 2007 and March 2010. The authors ask the questions that we’ve seen asked before about a variety of bailouts, roughly:
- Were the bailed-out banks worse than the non-bailed-out-banks, pre-bailouts?, and
- Did they stay worse after the bailouts?
The answer to the first question is always yes, which you could figure out a priori.1 The answer to the second question is usually yes too. As I said about a previous study, “bank bailouts are designed to let banks keep getting up to their old tricks; if you wanted them to stop doing that you’d let them go bankrupt.”
But here it’s no, so, yay! The authors are looking specifically at interactions of TAF funding and liquidity risk; the idea is something like “a lot of banks did too much short-term funding of long-term assets, and when the funding markets blew up they were in trouble, and TAF was designed to save them, and it did, but did they learn any lessons?” And they did:
Banks that benefited from the TAF program exhibit ex ante higher levels of liquidity risk proxies. Liquidity risk measures indicate that banks with a more severe maturity mismatch are most exposed to the freezing of the interbank market and are unable to roll over their short-term liabilities during the crisis. Therefore, they are more likely to participate in the TAF program. …
TAF program participation implies a larger contraction of liquidity risk. The larger the amount of reserves received, the bigger the reduction in liquidity risk. In other words, TAF banks were able to adjust faster the structure of their debt maturity. This finding contradicts the hypothesis of potential moral hazard problems associated with TAF-like programs.
You could question that last comment – the moral hazard is before the bailout, not after! – but, yeah, all right: TAF sort of worked. The banks who received it saw the error of their ways and termed out their funding more quickly than the banks who didn’t.
I’m at a loss for a mechanism here; a cynical mechanism is that larger and more government-supported banks had more ready access to the long-term funding markets, while smaller and less-supported banks had to continue relying on … is “ST Liabilities” here basically retail deposits? But the authors have their own suggested mechanism, which is cute:
This result can be explained by the fact that despite the fact that TAF banks were not subject to additional controls by the Fed or any other regulator, these banks might have felt themselves ‘under scrutiny’ and might have reacted accordingly, in order to look better when reassessed later on.
I’d note that, unlike TAF, TARP sort of did subject banks to additional regulatory controls, and yet by some accounts TARP banks got riskier faster, post-bailout, than non-TARP banks. Perhaps the moral of the story is that all bailouts should come with no strings attached, because then banks will know that the government is trusting them with a Serious Responsibility and so will feel a deep internal drive not to let the government down.2
Anyway, like I said, the moral hazard is before the bailout, not after: it’s not how you behave while taking bailout money that counts, but how you behave in the expectation that bailout money will be forthcoming. The authors found that “participation to the [TAF] programme is more likely for banks with higher level of asset-backed securities and mortgage-backed securities.” And the FT found the other day that this year “US banks have increased their holdings of structured financial products to the highest level since 2009 in an effort to boost profits in the face of continued record low interest rates.” Circle of life.
1. I guess. I mean, the a priori argument is “bad banks get bailed out, good banks don’t need to be bailed out,” on whatever your metric of goodness/badness is. This is not necessarily true, either on positive “treat everyone the same to avoid bailout panic” or negative/cynical “politically favored banks get bailouts they don’t need” grounds. The fact that all of these studies find that bailed-out banks were riskier ex ante I guess argues against both of those theories.
2. So that’s obviously, like, 80% sarcastic, but there’s actually something to be said for it from a behavioral-finance perspective. Day-care-lateness fines and whatnot. Someone should make this argument seriously.