Decision-Making During the Crisis: Why Did the Treasury Let Commercial Banks Fail?

Abstract

Limited attention has been paid to the comparative fate of banks benefiting from TARP Capital Purchase Program (CPP) funding and less fortunate banks subject to FDIC resolution. We address this omission by investigating two core issues. One is whether commercial banks that ended up being subject to FDIC resolution received CPP funds. The other is whether the non-allocation of CPP funds forced viable commercial banks into FDIC receivership. Our findings show almost no overlap between CPP-funded and FDIC-resolved commercial banks, but we provide evidence that a significant number of FDIC-resolved banks could have avoided receivership if they had been allocated CPP funding. By comparing estimated funding and resolution costs we also show that bailing out more banks would have been cost-efficient. While our results do not allow for any policy suggestion on the optimality of bail-outs per se, they suggest that once a bail-out program is already on the table, it is better to err on the side of rescuing too many rather than too few banks.

Keywords: Resolution, Bail-out, Commercial Bank, CPP, Financial crisis, Bankruptcy

JEL Classification: G21, G28, G33, K23, K29