Were Bank Bailouts Effective during the 2007-2009 Financial Crisis? Evidence from Counterparty Risk in the Global Hedge Fund Industry

Abstract:     
We examine whether bank bailout programs initiated in seven countries during the 2007-2009 global financial crisis reduced counterparty risk in the financial system using the hedge fund industry as a laboratory. Hedge funds have extensive and economically significant ties to banking institutions and these links spurred fears of systemic risk among regulators and investors. We find that the rescue of financial institutions offering prime brokerage, custodial and investment advisory services to hedge funds was followed in the short term (up to six months) by reduced probability of hedge fund liquidation. However, only the rescue of custodians reduced hedge fund illiquidity or the ability of funds to meet clients’ redemption requests.

Keywords: Bailouts, counterparty risk, hedge funds, terminations, liquidity

JEL Classifications: G21, G23

Working Paper Series