Financial Black-Holes: The Interaction of Financial Regulation and Bailout Guarantees

60 Pages Posted: 21 Feb 2011

See all articles by Romain G. Rancière

Romain G. Rancière

University of Southern California

Aaron Tornell

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: February 2011

Abstract

This paper argues that the U.S. financial crisis is a new type of crisis: a "financial black hole." Financial black holes are characterized by the breaking-up of credit market discipline and the large-scale financing of negative NPV projects. In a theoretical model, we explain how the combination of perceived government guarantees and the ability to issues catastrophe-bond-like liabilities generate financial black holes. We then show that the stylized facts of the U.S. economy are consistent with a financial black hole equilbrium.

Keywords: Bailout Guarantees, Derivatives, Financial Crisis, Financial Regulation

JEL Classification: E22, E60, F34, G01, G18

Suggested Citation

Rancière, Romain G. and Tornell, Aaron, Financial Black-Holes: The Interaction of Financial Regulation and Bailout Guarantees (February 2011). CEPR Discussion Paper No. DP8248. Available at SSRN: https://ssrn.com/abstract=1763657

Romain G. Rancière (Contact Author)

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Aaron Tornell

University of California, Los Angeles (UCLA) - Department of Economics ( email )

Box 951477
Bunche Hall 8387
Los Angeles, CA 90095-1477
United States
310-794-1686 (Phone)
310-825-9528 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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