TARP and Market Discipline: Evidence on the Moral Hazard Effects of Bank Recapitalizations
52 Pages Posted: 16 Oct 2015
Date Written: October 9, 2015
We examine the moral hazard effects of bank recapitalizations by assessing the impact of the U.S. TARP program on market discipline exerted by subordinated debt-holders using a sample of 123 bank holding companies over the period 2004-2013. Predicted distress risk has a consistently positive and significant effect on sub-debt spreads, suggesting the presence of market discipline. A higher bailout probability significantly reduces the risk-sensitivity of spreads for the full sample, indicating a moral hazard effect of recapitalizations. This appears to be a too-big-to-fail effect, as it is absent when the largest banks are dropped from the sample. Results also indicate that it is transitory. We also find a large effect of the crisis, appearing both as a uniform rise in, and a heightened risk sensitivity of, sub-debt spreads during the crisis.
Keywords: bank bailouts, moral hazard, distress risk, capital injections, TARP, CPP, market discipline, nancial crisis
JEL Classification: E50, G01, G21, G28, H12
Suggested Citation: Suggested Citation