A Theory of Failed Bank Resolution: Technological Change and Political Economics

58 Pages Posted: 23 Oct 2012

See all articles by Robert DeYoung

Robert DeYoung

University of Kansas School of Business

Michal K. Kowalik

Federal Reserve Banks - Federal Reserve Bank of Boston

Jack Reidhill

FDIC, Division of Insurance and Research

Date Written: August 8, 2011

Abstract

We model the failed bank resolution process as a repeated game between a utility-maximizing government resolution authority (RA) and a profit-maximizing banking industry. Limits to resolution technology and political/economic pressure create incentives for the RA to bail out failed complex banks; the inability of the RA to credibly commit to closing these banks creates an incentive for bank complexity. We solve the game in mixed strategies and find equilibrium conditions remarkably descriptive of government responses to actual and potential large bank insolvencies during the recent financial crisis. The central role of the technology constraint in this model highlights a crucial determinant of failed bank resolution policy that has been overlooked in the theory literature to date; without improved resolution technologies, future bank bailouts are inevitable. The effects of political pressure in this model remind us that regulatory reform (e.g., Dodd-Frank) is only as good as the regulators that implement the reform.

Keywords: bank failures, failed bank resolution, bankruptcy, FDIC

JEL Classification: G21, G28

Suggested Citation

DeYoung, Robert and Kowalik, Michal K. and Reidhill, Jack, A Theory of Failed Bank Resolution: Technological Change and Political Economics (August 8, 2011). Available at SSRN: https://ssrn.com/abstract=2165527 or http://dx.doi.org/10.2139/ssrn.2165527

Robert DeYoung (Contact Author)

University of Kansas School of Business ( email )

Capitol Federal Hall
1654 Naismith Drive
Lawrence, KS 66045
United States
785-864-1806 (Phone)

Michal K. Kowalik

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

Jack Reidhill

FDIC, Division of Insurance and Research ( email )

Washington, DC 20429
United States

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