Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts

50 Pages Posted: 21 Jul 2009 Last revised: 14 May 2023

See all articles by Emmanuel Farhi

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Jean Tirole

University of Toulouse 1 - Industrial Economic Institute (IDEI); University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2009

Abstract

The paper elicits a mechanism by which private leverage choices exhibit strategic complementarities through the reaction of monetary policy. When everyone engages in maturity transformation, authorities have little choice but facilitating refinancing. In turn, refusing to adopt a risky balance sheet lowers the return on equity. The key ingredient is that monetary policy is non-targeted. The ex post benefits from a monetary bailout accrue in proportion to the number amount of leverage, while the distortion costs are to a large extent fixed. This insight has important consequences. First, banks choose to correlate their risk exposures. Second, private borrowers may deliberately choose to increase their interest-rate sensitivity following bad news about future needs for liquidity. Third, optimal monetary policy is time inconsistent. Fourth, there is a role for macro-prudential supervision. We characterize the optimal regulation, which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets. We establish the robustness of our insights when the set of bailout instruments is endogenous and characterize the structure of optimal bailouts.

Suggested Citation

Farhi, Emmanuel and Tirole, Jean, Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts (July 2009). NBER Working Paper No. w15138, Available at SSRN: https://ssrn.com/abstract=1434652

Emmanuel Farhi (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Jean Tirole

University of Toulouse 1 - Industrial Economic Institute (IDEI) ( email )

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University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ) ( email )

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Toulouse, 31000
France

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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