Guarantor of Last Resort

102 Pages Posted: 12 Sep 2018 Last revised: 13 Feb 2019

Date Written: February 11, 2019

Abstract

The optimal response to a financial crisis entails addressing two, often conflicting, demands: stopping the panic and starting the clock. When short-term depositors flee, banks can be forced to sell assets at fire-sale prices, causing credit to contract and real economic activity to decline. To reduce these adverse spillover effects, policymakers routinely intervene to stop systemic runs. All too often, however, policymakers deploy stopgap measures that allow the underlying problems to fester. To promote long-term economic health, they must also ferret out the underlying problems and allocate the losses that cannot be avoided. A well-designed guarantor of last resort can help address these conflicting demands. Just-in-time guarantees keep private capital in the system, providing policymakers the time that they need to develop a viable plan to address deficiencies. A strict time limit on those guarantees ensures that policymakers and market participants remain motivated to devise such a plan, avoiding the alternative pitfall of excessive forbearance.

Keywords: financial crises, central banking, financial regulation, regulatory structure, crisis management, forbearance

JEL Classification: E44, G20, G21, G23, G28, H11, H12

Suggested Citation

Judge, Kathryn, Guarantor of Last Resort (February 11, 2019). Texas Law Review, Forthcoming; Columbia Law and Economics Working Paper No. 589. Available at SSRN: https://ssrn.com/abstract=3247265 or http://dx.doi.org/10.2139/ssrn.3247265

Kathryn Judge (Contact Author)

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States

HOME PAGE: http://www.law.columbia.edu/fac/Kathryn_Judge

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