Guarantees and Capital Infusions in Response to Financial Crises A: Haircuts and Resolutions

Yale Program on Financial Stability Case Study 2015-3A-V1

16 Pages Posted: 30 Jan 2016

See all articles by June Rhee

June Rhee

Yale University - Yale Program on Financial Stability; Harvard Law School; Yale University - Yale Program on Financial Stability

Andrew Metrick

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Date Written: July 30, 2015

Abstract

After the mortgage market meltdown in mid-2007 and during the financial crisis in 2008, major financial institutions around the world were on the verge of collapsing one after another. Faced with these troubles, the government had to respond quickly to contain the crisis as efficiently as possible. It was, however, limited in resources, time and experience. To make matters worse, the complexity and opaqueness of the financial market and these institutions greatly affected the governments’ ability to design an efficient and consistent method to contain the crisis. Shortly after Lehman Brothers filed for bankruptcy on September 15, 2008, American International Group (AIG) was also in deep trouble and close to failure when the Federal Reserve decided to bailout the institution. Washington Mutual (WaMu) and Wachovia were also facing collapse due to their exposure in risky mortgage products around the same time. WaMu closed and the Federal Deposit Insurance Corporation (FDIC), appointed as a receiver. When the FDIC was appointed, the FDIC was able to arrange a transaction that protected all depositors in the bank and transferred all ongoing operations to JP Morgan Chase without any cost to the FDIC Deposit Insurance Fund. In contrast to WaMu, in the case of Wachovia the FDIC Board of Directors initially approved a sale of Wachovia through a closed bank resolution to Citigroup under the FDIC’s systemic risk authority. However, Wachovia’s Board of Directors subsequently decided to approve a sale – with no FDIC assistance – to Wells Fargo. This case provides details on the background and government response for each troubled financial institution during the financial crisis, and the rationale behind the design of each response.

Keywords: Haircuts, Resolution, WaMu, Wachovia, Financial Crisis, FDIC

JEL Classification: G01, G21, G28

Suggested Citation

Rhee, June and Metrick, Andrew, Guarantees and Capital Infusions in Response to Financial Crises A: Haircuts and Resolutions (July 30, 2015). Yale Program on Financial Stability Case Study 2015-3A-V1 . Available at SSRN: https://ssrn.com/abstract=2723446 or http://dx.doi.org/10.2139/ssrn.2723446

June Rhee (Contact Author)

Yale University - Yale Program on Financial Stability ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Harvard Law School ( email )

1563 Massachusetts Ave
Cambridge, MA 02138
United States

Yale University - Yale Program on Financial Stability

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States

Andrew Metrick

Yale School of Management ( email )

165 Whitney Avenue
New Haven, CT 06511
United States
(203)-432-3069 (Phone)

HOME PAGE: http://faculty.som.yale.edu/andrewmetrick/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yale University - Yale Program on Financial Stability

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States

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