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外文资料
Financial ?rm bankruptcy and systemic risk
In Fall 2008 when the Federal Reserve and the Treasury injected $85 billion into the insurance behemoth American International Group (AIG), themoney lent to AIGwent straight to counterparties, and very few funds remained with the insurer. Among the largest recipients was Goldman Sachs, to whomabout $12 billionwas paid to undoAIG’s credit default swaps (CDSs). The bailout plan focused on repaying the debt by slowly selling off AIG’s assets, with no intention of maintaining jobs or allowing the CDSmarket to continue to function as before. Thus, the government’s effort to avoid systemic risk with AIG was mainly about ensuring that ?rms with which AIG had done business did not fail as a result. The concerns are obviously greatest vis-a-vis CDSs, ofwhich AIG had over $400 billion contracts outstanding in June 2008.
In contrast, the government was much less enthusiastic about aiding General Motors, presumably because they believed its failure would not cause major macroeconomic repercussions by imposing losses on related ?rms. This decision is consistent with the view in macroeconomic
research that financial?rmbankruptcies pose a greater amount of systemic risk than nonfinancial firmbankruptcies. For example, Bordo and Haubrich (2009) conclude that “...more severe ?nancial events are associated withmore severe recessions...” Likewise, Bernanke (1983) argues the Great Depressionwas so severe because ofweakness in the banking systemthat affected the amount of credit available for investment. Bernanke et al. (1999) hypothesize a financial accelerator mechanism, whereby distress in one sector of the economy leads to more precarious balance sheets and tighter credit conditions. This in turn leads to a drop in investment, which is followed by less lending and a widespread downturn. Were shocks to the economy always to come in the form of distress at non?nancial ?rms, these authors argue that the business downturns would not be so severe.
We argue instead that the contagious impact of a nonfinancial firm’s bankruptcy is expected to be far larger than that of a financial ?rm like AIG, although neither would be catastrophic to the U.S. economy through counterparty risk channels. This is not to say that an episode ofwidespread financial distress among our largest banks would not be followed by an especially severe recession, only that such failures would not cause a recession or affect the depth of a recession. Rather such bankruptcies are symptomatic of common factors in portfolios that lead to wealth losses regardless of whether any firm ?les for bankruptcy.
Pervasive ?nancial fragility may occur because the failure of one ?rm leads to the failure of other ?rms which cascades through the system (e.g., Davis and Lo, 1999; Jarrow and Yu, 2001). Or systemic risk may wreak havoc when a number of ?nancial ?rms fail simultaneously, as in the Great Depression when more than 9000 banks failed (Benston, 1986). In the former case, the failure of one ?rm, such as AIG, Lehman Brothers or Bear Stearns, could lead to widespread failure through ?nancial contracts such as CDSs. In the latter case, the fact that so many ?nancial institutions have failed means that both the money supply and the amount of credit in the economy could fall so far as to cause a large drop in economic activity (Friedman and Schwartz, 1971).While a weak ?nancial systemcould cause a recession, the recession would not arise because one ?rm was allowed to ?le bankruptcy. Further, should one or the other ?rmgo bankrupt, the non?nancial ?rmwould have the greater impact on the economy.
Such extreme real effects that appear to be the result of ?nancial ?rm fragility have led to a large emphasis on the prevention of systemic risk problems by regulators. Foremost among these policies is “too big to fail” (TBTF), the logic of which is that the failure of a large ?nancial institution will have ramifications for other ?nancial institutions and therefore the risk to the economywould be enormous. TBTF was behind the Fed’s decisions to orchestrate the merger of Bear Stearns and J.P.
Morgan Chase in 2008, its leadership in the restructuring of bank loans owed by Long Term Capital Management (LTCM), and its decision to prop up AIG. TBTF may be justi?ed if the outcome is prevention of a major downswing in the economy. However, if the systemic risks in these episodes have been exaggerated or the salutary effects of these actions overestimated, then the cost to the ef?ciency of the capital allocation system may far outweigh any potential bene?ts from attempting to avoid another Great Depression.
No doubt, no regulator wants to take the chance of standing down while watching over another systemic risk crisis, sowe do not have the ability to examine empiricallywhat happens to the economy when regulators back off. There are very fewinstances in themodern history of the U.S.where regulators allowed the bankruptcy of amajor ?nancial ?rm.Most recently,we can point to the bankruptcy of Lehman,which the Fed pointedly allowed to fail.However,with only one obvious casewhere TBTFwas abandoned, we have only an inkling of how TBTF policy affects systemic risk. Moreover, at the same time that Lehman failed, the Fed was intervening in the commercial paper market and aiding money marketmutual fundswhile AIGwas downgraded and subsequently bailed out. In addition, the Federal Reserve and the Treasury were scaremongering about the prospects of a second Great Depression to make the passage of TARPmore likely. Thuswewill never knowif
themarket downturn that followed the Lehman bankruptcy re?ected fear of contagion from Lehman to the real economy or fear of the depths of existing problems in the real economy that were highlighted so dramatically by regulators.
In this paper we analyze the mechanisms by which such risk could cause an economy-wide col-lapse.We focus on two types of contagion that might lead to systemic risk problems: (1) information contagion,where the information that one ?nancial ?rmis troubled is associatedwith negative shocksat other ?nancial institutions largely because the ?rms share common risk factors; or (2) counterparty contagion,where one important ?nancial institution’s collapse leads directly to troubles at other cred-itor ?rms whose troubles snowball and drive other ?rms into distress. The ef?cacy of TBTF policies depends crucially on which of these two types of systemic riskmechanisms dominates.Counterparty contagion may warrant intervention in individual bank failureswhile information contagion does not.
If regulators do not step in to bail out an individual ?rm, the alternative is to let it fail. In the case of a bank, the process involves the FDIC as receiver and the insured liabilities of the ?rmare very quickly repaid. In contrast, the failure of an investment bank or hedge fund does not involve the FDIC andmay closely resemble a Chapter 11 or Chapter 7 ?ling of a non?nancial ?rm. However, if the nonbank ?nancial ?rm in
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