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Efficient Recapitalization

54 Pages Posted: 17 Mar 2009  

Thomas Philippon

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Philipp Schnabl

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: February 28, 2009

Abstract

We analyze the relative efficiency of government interventions against debt overhang when the government is either unable or unwilling to hurt long term debt holders. We first consider three interventions that have actually been used or seriously considered: buying back risky assets, injecting capital, and providing guarantees for new debt issuances. With symmetric information or compulsory participation, all the interventions are equivalent. Asset buyback and debt guarantee programs are still equivalent with voluntary participation and asymmetric information about the quality of banks' balance sheets, but they are strictly dominated by equity injections. We also find that buying back assets is the worse solution when there is adverse selection across asset classes, and that taking deposit insurance into account reduces significantly the net cost of government interventions. Finally, we show how to construct a constrained-efficient mechanism where the government makes a junior loan at a subsidized rate in exchange for call options on equity.

Suggested Citation

Philippon, Thomas and Schnabl, Philipp, Efficient Recapitalization (February 28, 2009). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1361197 or http://dx.doi.org/10.2139/ssrn.1361197

Thomas Philippon

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Philipp Schnabl (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/pschnabl/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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