NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References to International Finance Discussion Papers (other than an acknowledgment that the writer has had access to unpublished material) should be cleared with the author or authors. Recent IFDPs are available on the Web at www.federalreserve.gov/pubs/ifdp/. This paper can be downloaded without charge from Social Science Research Network electronic library at www.ssrn.com. The Effect of TARP on Bank Risk-Taking

Government support to banks through the provision of explicit or implicit guarantees can affect the willingness of banks to take on risk by reducing market discipline or by increasing charter value. We use an international sample of bank data and government support to banks for the periods 2003-2004 and 2009-2010. We find that more government support is associated with more risk-taking by banks, especially during the financial crisis (2009-10), even after controlling for several bank-specific and country-level factors. We use several measures of government support and bank risk-taking, and the results are robust to various possible misspecification issues. We also find that restricting banks ’ range of activities ameliorates the moral hazard problem. We conclude that policy measures to counteract this moral hazard problem should be geared towards strengthening market discipline in the banking sector.

Abstract This paper examines the welfare implications of bank capital requirements in a general equilibrium model in which a dynamic banking sector endogenously determines aggregate growth. Due to government bailouts, banks engage in risk-shifting, thereby depressing investment efficiency; furthermore, they over-lever, causing fragility in the financial sector. Capital regulation can address these distortions and has a first-order effect on both growth and welfare. In the model, the optimal level of minimum Tier 1 capital requirement is 8%, greater than that prescribed by both Basel II and III. Increasing bank capital requirements can produce welfare gains greater than 1% of lifetime consumption.

of bank insolvency and resolution

We propose a framework for testing the effects of changes in bank resolution regimes on bank behavior, particularly on a variety of risk- and business-model measures. By exploiting the differential relevance of recent changes in U.S. bank resolution laws (i.e., the introduction of the Orderly Liquidation Authority, (OLA)) for different types of banks, we are able to simulate a quasi-natural experiment to test otherwise endogenous effects in a difference-in-difference framework. To the best of our knowledge, this identification strategy is unique in its application to regulatory changes in bank resolution. To test our hypotheses, we assemble a three-level dataset: holding aggregates (including stock market data), bank-level data, and loan-level data. We find that banks that are more affected by the introduction of the OLA significantly decrease their overall risk-taking and shift their business model and new loan origination towards lower risk, indicating the overall effectiveness of the regime change. This effect, however, does not hold for the largest and most systemically important banks, indicating that the application of the OLA does not represent a credible threat to these institutions, leaving the too-big-to-fail problem unresolved. Finally, we find no evidence of gambling between the announcement and the enactment of the OLA, presumably because the legislation was passed relatively quickly. Our results contribute to the emerging literature evaluating the implications of new regulatory policies and yield relevant conclusions for the design of bank resolution law, e.g., in the context of the European Banking Union.

This dissertation studies the effects of economic policies on investment, growth and welfare. The first chapter examines the welfare implications of bank capital requirements in a general equilibrium model in which a dynamic banking sector endogenously determines aggregate growth. Due to government bailouts, banks engage in risk-shifting, thereby depressing investment efficiency; furthermore, they over-lever, causing fragility in the financial sector. Capital regulation can address these distortions and has a first-order effect on both growth and welfare. In the model, the optimal level of minimum Tier 1 capital requirement is 8%, greater than that prescribed by both Basel II and III. Increasing bank capital requirements can produce welfare gains greater than 1 % of lifetime consumption. The second chapter studies fiscal policy design in an economy in which endogenous growth risk and asset prices are a first-order concern. When (i) the representative household has recursive preferences, and (ii) growth is endogenously sustained through R&D investment, fiscal policy alters both the composition of intertemporal consumption risk and the incentives to innovate. Tax policies aimed at short-run stabilization may substantially increase long run tax and growth risks and reduce both average growth and welfare. In contrast, policies oriented toward asset price stabilization increase growth, wealth and welfare by lowering the

Abstract not found

neoclassical economics, behavioural

This paper investigates the relation between corporate political connections and government investment. We study various forms of political influence, ranging from passive connections between firms and politicians, such as those based on politicians ’ voting districts, to active forms, such as lobbying, campaign contributions, and employment of connected directors. Using hand-collected data on firm applications for TARP funds, we find that politically connected firms are more likely to be funded, controlling for other characteristics. Yet investments in politically connected firms underperform those in unconnected firms. Overall, we show that connections between firms and regulators are associated with distortions in investment efficiency.

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