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Safety-Net Benefits Conferred on Difficult-to-Fail-and-Unwind Banks in the US and EU Before and During the Great Recession

44 Pages Posted: 29 Jan 2011 Last revised: 16 Aug 2011

Santiago Carbo-Valverde

Bangor Business School

Edward J. Kane

Boston College - Department of Finance; National Bureau of Economic Research (NBER)

Francisco Rodriguez-Fernandez

University of Granada - Department of Economic Theory and History

Multiple version iconThere are 3 versions of this paper

Date Written: August 15, 2011

Abstract

This paper investigates the links between regulatory arbitrage, financial instability, and taxpayer loss exposures. We model and estimate ex ante safety-net benefits from increased leverage and asset volatility at a sample of large banks in US and Europe during 2003-2008. Hypothesis tests indicate that, in both crisis and precrisis years, difficult-to-fail-and-unwind (DFU) banks enjoyed substantially higher ex ante benefits than other institutions. Compared to the US sample, safety-net benefits prove significantly larger for DFU firms in Europe and bailout decisions are less driven by asset size. Introducing a proxy for differences in government susceptibility to regulatory capture helps to explain bailout decisions in Europe. Our findings suggest that authorities in both venues could better contain safety-net benefits if they refocused their information systems on monitoring volatility as well as capital.

Keywords: financial safety net, too big to fail, financial crisis, financial subsidies,regulatory arbitrage

JEL Classification: G21,G01

Suggested Citation

Carbo-Valverde, Santiago and Kane, Edward J. and Rodriguez-Fernandez, Francisco, Safety-Net Benefits Conferred on Difficult-to-Fail-and-Unwind Banks in the US and EU Before and During the Great Recession (August 15, 2011). Available at SSRN: https://ssrn.com/abstract=1750330 or http://dx.doi.org/10.2139/ssrn.1750330

Santiago Carbo-Valverde

Bangor Business School ( email )

Bangor Business School
College Road
Gwynedd LL57 2DG, Wales LL57 2DG
United Kingdom

Edward J. Kane (Contact Author)

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
520-299-5066 (Phone)
617-552-0431 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Francisco Rodriguez-Fernandez

University of Granada - Department of Economic Theory and History ( email )

Granada
Spain

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