Financial Stability
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Stress, Contagion, and Transmission: 2020 Financial Stability Conference
Once a year, financial system regulators and economists meet to present and discuss the latest research on financial stability at a conference sponsored by the Federal Reserve Bank of Cleveland and the Office of Financial Research. The major focus of discussion during the 2020 conference was the impact of the COVID-19 pandemic on the financial system. This Commentary summarizes the ideas and insights presented in the research papers and keynote speeches. Read More
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How Well Does the Cleveland Fed’s Systemic Risk Indicator Predict Stress?
A number of financial stress measures were developed after the financial crisis of 2007–2009 in the hope that they could provide regulators with advance warning of conditions that might warrant a corrective response. The Cleveland Fed’s systemic risk indicator is one such measure. This Commentary provides a review of the SRI’s performance from 2001 to 2020 and finds that it has performed well, providing a reliable, valid, and timely signal of elevated levels of financial system stress. Read More
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Subprime May Not Have Caused the 2000s Housing Crisis: Evidence from Cleveland, Ohio
During the 2000s housing bust, Cleveland’s Slavic Village was dubbed “ground zero of the foreclosure crisis” by the national media. Despite this, during the preceding housing boom Cleveland had stable house price growth and relatively low mortgage debt growth, a stark contrast to circumstances in areas such as California that had exceptionally high house price and mortgage debt growth. What explains the relatively minor housing boom and perceived sharp downturn in Cleveland? In this Commentary I show that while subprime debt was a prominent source of debt in Cleveland and especially in its Slavic Village neighborhood during the 2000s, it is difficult to peg subprime debt as playing a causal role in the subsequent foreclosure crisis. Read More
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Financial Stability: Risks, Resilience, and Policy
As the COVID-19 pandemic and its economic fallout continue, policymakers keep a watchful eye on the stability of the financial system. Having learned many lessons from the financial crisis of 2007–2009, they may again turn to that crisis for insights into potential vulnerabilities emerging in the financial sector and ways to make financial markets and institutions more resilient to shocks. At a recent conference on financial stability, 12 papers and two keynotes explored this ground. This Commentary summarizes the papers’ findings and the keynotes. Read More
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A Brief History of Bank Capital Requirements in the United States
Modern capital requirements can appear to be overly complex, but they reflect centuries of practical experience, compromises between different regulators, and legal and financial systems that developed over time. This Commentary provides a historical perspective on current discussions of capital requirements by looking at how the understanding of bank capital and the regulations regarding its use have changed over time. Read More
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Banker Compensation, Relative Performance, and Bank Risk
A multi-agent, moral-hazard model of a bank operating under deposit insurance and limited liability is used to analyze the connection between compensation of bank employees (below CEO) and bank risk. Limited liability with deposit insurance is a force that distorts effort down. However, the need to increase compensation to risk-averse employees in order to compensate them for extra bank risk is a force that reduces this effect. Optimal contracts use relative performance and are implementable as a wage with bonuses tied to individual and firm performance. The connection between pay for performance and bank risk depends on correlation of returns. If employee returns are uncorrelated, the form of pay is irrelevant for risk. If returns are perfectly correlated, a low wage can indicate risk. Connections to compensation regulation and characteristics of organizations are discussed. Read More
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The Impact of Stricter Merger Control on Bank Mergers and Acquisitions. Too-Big-To-Fail and Competition
The effect of regulations on the banking sector is a key question for financial intermediation. This paper provides evidence that merger control regulation, although not directly targeted at the banking sector, has substantial economic effects on bank mergers. Based on an extensive sample of European countries, we show that target announcement premia increased by up to 16 percentage points for mergers involving control shifts after changes in merger legislation, consistent with a market expectation of increased profitability. These effects go hand-in-hand with a reduction in the propensity for mergers to create banks that are too-big-to-fail in their country. Read More
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The Effect of Possible EU Diversification Requirements on the Risk of Banks’ Sovereign Bond Portfolios
Recent policy discussion includes the introduction of diversification requirements for sovereign bond portfolios of European banks. In this paper, we evaluate the possible effects of these constraints on risk and diversification in the sovereign bond portfolios of the major European banks. First, we capture the dependence structure of European countries’ sovereign risks and identify the common factors driving European sovereign CDS spreads by means of an independent component analysis. We then analyze the risk and diversification in the sovereign bond portfolios of the largest European banks and discuss the role of “home bias,” i.e., the tendency of banks to concentrate their sovereign bond holdings in their domicile country. Finally, we evaluate the effect of diversification requirements on the tail risk of sovereign bond portfolios and quantify the system-wide losses in the presence of fire-sales. Under our assumptions about how banks respond to the new requirements, demanding that banks modify their holdings to increase their portfolio diversification may mitigate fire-sale externalities, but it may be ineffective in reducing portfolio risk, including tail risk. Read More
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Macroprudential Policy: Results from a Tabletop Exercise
This paper presents a tabletop exercise designed to analyze macroprudential policy. Several senior Federal Reserve officials were presented with a hypothetical economy as of 2020:Q2 in which commercial real estate and nonfinancial debt valuations were very high. After analyzing the economy and discussing the use of monetary and macroprudential policy tools, participants were then presented with a hypothetical negative shock to commercial real estate valuations that occurred in the second half of 2020. Participants then discussed the use of the tools during an incipient downturn. Some of the findings of the exercise were that during an asset boom, there were limits to the effectiveness of US macroprudential tools in controlling narrow risks and that changes to the fed funds rate may not always simultaneously meet macroeconomic and financial stability goals. Some other findings were that during a downturn, it would be desirable to use high-frequency indicators for deciding when to release the countercyclical capital buffer (CCyB) and that tensions exist between microprudential and macroprudential goals when using the CCyB and the stress test. Read More
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Causal Impact of Risk Oversight Functions on Bank Risk: Evidence from a Natural Experiment
Our goal is to document the causal impact of having a board-level risk committee (RC) and a management-level executive designated as chief risk officer (CRO) on bank risk. The Dodd Frank Act requires bank holding companies with over $10 billion of assets to have an RC, while those with over $50 billion of assets are additionally required to have a CRO to oversee risk management. The innovation that allows us to document a causal impact is our research design. First, we use the passage of the Dodd Frank Act as a natural experiment that forced noncompliant firms to adopt an RC and appoint a CRO. We adopt the difference-in-difference approach to estimate the change in risk following RC and CRO adoption. Second, we use the regression discontinuity approach centered on the $10 billion and $50 billion thresholds whereby firms that were just below the threshold were not required by the law to install an RC and to recruit a CRO, while those just above the thresholds had to comply with the regulation. Our contribution is to document that neither the RC nor the CRO have a causal impact on risk near these thresholds. However, we do find strong evidence of risk reduction following the passage of the law. Read More
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Asset Commonality in US Banks and Financial Stability*
One potential threat to a stable financial system is the phenomenon of contagion, where a risk that is ordinarily small becomes a problem because of the way it spreads to other institutions. Researchers have investigated multiple channels through which contagion might occur. We look at two--banks borrowing from each other and banks holding similar types of assets--and argue that the latter is a potential source of systemic risk. We review recent data on asset concentrations and capitalization levels of the largest US banks and conclude that the overall risk from this particular contagion channel is at present likely limited. Read More
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The Threats, the Criminals, the Motives—Cybersecurity at the Fed
Cleveland Fed cybersecurity experts and others explain how the Fed works to promote awareness, preparedness, and vigilance against the hackers who work to threaten the stability of the financial sector. Read More
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Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation
We develop a stylized interbank market environment and use it to evaluate with experimental methods the effects of liquidity requirements. Baseline and liquidity-regulated regimes are analyzed in a simple shock environment, which features a single idiosyncratic shock, and in a compound shock environment, in which the idiosyncratic shock is followed by a randomly occurring second-stage shock. Interbank trading of the illiquid asset follows each shock. In the simple shock environment, we find that liquidity regulations reduce the incidence of bankruptcies, but at a large loss of investment efficiency. In the compound shock environment, liquidity regulations not only impose a loss of investment efficiency but also fail to reduce bankruptcies. Read More
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Are the New Basel III Capital Buffers Countercyclical? Exploring the Option of a Rule-Based Countercyclical Buffer
Countercyclical capital regulation can reduce the procyclicality of the banking system and dampen aggregate economic fluctuations. I describe two new capital buffers introduced in Basel III and discuss why their countercyclical effects may be small. If over time regulators want to increase the degree of countercyclicality of capital regulation, they might consider adopting a rule-based countercyclical buffer, that is, a buffer that is automatically lowered during recessions according to a rule. I present a conservative example of such a rule and its effects on capital requirements over the business cycle. Read More
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Stress Tests and Small Business Lending
Post-crisis stress tests have altered banks' credit supply to small business. Banks affected by stress tests reduce credit supply and raise interest rates on small business loans. Banks price the implied increase in capital requirements from stress tests where they have local knowledge, and exit markets where they do not, as quantities fall most in markets where stress-tested banks do not own branches near borrowers, and prices rise mainly where they do. These reductions in supply are concentrated among risky borrowers. Stress tests do not, however, reduce aggregate credit. Small banks increase their share in geographies formerly reliant on stress-tested lenders. Read More
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Using Economic Experiments to Improve Contingent Convertible Capital Bonds
This Commentary describes experiments conducted to study alternative designs for a new type of financial security, CoCo bonds, that is being used in some European countries to manage the risk of financial crises. CoCo bonds are bank-issued debt that converts to equity when a trigger is breached. The conversion into equity serves to recapitalize a bank during financial distress, precisely when it is hardest to raise capital. The types of trigger used for all CoCos issued thus far are defined in terms of book capital. The experiments we conducted explore the effects of using triggers that are based on market prices. Read More
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How Cyclical Is Bank Capital?
Using annual data since 1834 and quarterly data since 1959, I find a negative correlation between output and current and lagged values of the bank capital ratio, but a positive correlation with leading values, although except for the period since 1996 the numbers are mostly small and usually insignificant. The most significant correlations tend to reflect movements in bank assets, rather than capital itself, and although the pattern of aggregate correlations matches those of large banks, small banks show a different pattern, with strongly pro-cyclical capital ratios (counter-cyclical leverage). Read More
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Comparison of Small Bank Failures and FDIC Losses in the 1986–92 and 2007–13 Banking Crises
Failure rates of small commercial banks during the banking crisis of the late 1980s were about 7.6%, which is significantly higher than the 5.7% failure rate during the recent crisis. We compare failure rates in the two periods using a statistical model that allows us to decompose the effect of changes in bank characteristics and economic shocks on failure rates. We find that the severe economic shocks of the recent crisis had a larger impact on high bank failure rates than bank characteristics. Read More
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The Taste of Peer-to-Peer Loans
This working paper has been removed due to concerns that the underlying data sample used in the analysis does not support the paper’s conclusions. Read More
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Three Myths about Peer-to-Peer Loans
This Economic Commentary has been removed due to concerns that the underlying data sample used in the analysis does not support the paper’s conclusions. Read More
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The 1970s Origins of Too Big to Fail
In 1972, bank regulators bailed out the $1.2 billion Bank of the Commonwealth partly because they viewed it as “too big to fail.” We describe this bailout and subsequent ones through that of Continental Illinois in 1984 and use the descriptions to draw lessons about too-big-to-fail policy. We argue that some of the same issues that motivated bailouts during this earlier period, particularly worries about banking concentration, are relevant today. Read More
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Sizing Up Systemic Risk
Regulators now use a framework for identifying systemically important banking institutions that is based on five broad measures of bank structure. Though size is only one of these equally weighted measures, it seems to be the focus of the most attention. Read More
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The Optimal Response of Bank Capital Requirements to Credit and Risk in a Model with Financial Spillovers
This paper studies optimal bank capital requirements in an economy where bank losses have financial spillovers. Read More
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Origins of Too-Big-to-Fail Policy
This paper traces the origin of the too-big-to-fail problem in banking to the bailout of the $1.2 billion Bank of the Commonwealth in 1972. It describes this bailout and those of subsequent banks through that of Continental Illinois in 1984. Read More
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Where the Wild Things Are: Measuring Systemic Risk through Investor Sentiment
This paper presents a systemic risk measure derived from investor sentiment that has predictive power over future economic activity and market returns. Read More
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Too-Big-to-Fail before the Fed
Before the Federal Reserve existed, private bank clearing houses provided emergency lending to member banks during financial crises. This behavior strongly suggests that "too-big-to-fail" is not the problem causing modern crises. Read More
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Sovereign Default in the US
I use evidence from the Arkansas state archives to provide a description of the events surrounding the default of the state in 1933. I examine the evolution of the negotiations, the outcomes, and the role of fiscal policy. Read More
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Where the Wild Things Are: Measuring Systemic Risk through Investor Sentiment
This paper presents a systemic risk measure derived from investor sentiment that has predictive power over future economic activity and market returns. Read More
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Financial Stability Work Continues
The third annual Financial Stability Conference highlights research and advances in data requirements for macroprudential policy, systemic risk measurement, and forecasting tools. Read More
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Mortgage Companies and Regulatory Arbitrage
Mortgage companies do not fall under the strict regulatory regime of depository institutions. We show that this gap resulted in regulatory arbitrage and allowed bank holding companies to circumvent consumer compliance regulations. Read More
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Evaluating the Information Value for Measures of Systemic Conditions
This paper provides a general-purpose evaluation framework for assessing the information value of measures of systemic conditions. Read More
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Mixed Signals on Financial Stability
Financial markets are still in what seems to be a tentative recovery period, even 6 years after the end of the Great Recession. We look at the banking trends observed through 2014 and consider what they may signal about the financial sector in 2015. Read More
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Did Core Deposits Hedge Loan-Commitment Risk during the Financial Crisis?
During financial crises, banks can experience heightened demand for liquidity as customers draw down lines of credit and other loan commitments. Some researchers say core deposits naturally rise to meet the demand. Do they? Read More
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How Cyclical Is Bank Capital?
We look at the question of the cyclicality of bank capital from several vantage points, using both detailed recent data on risk-weighted assets and several sources of annual data going back to 1834. Read More
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Policy Watch: Preventing Crises and Protecting Pocketbooks
The 114th Congress began work on 1.3.2015 implementing Dodd–Frank, reforming Fannie Mae and Freddie Mac, and studying what banks are doing to keep financial data safe are all still on the docket. Read More
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Tracking Recent Levels of Financial Stress - January 2015
During most of the fourth quarter of 2014, the Cleveland Financial Stress Index (CFSI) remained in Grade 2 (a historically normal stress range). Read More
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Centrality-based Capital Allocations
This paper looks at the effect of capital rules on a banking system that is connected through correlated credit exposures and interbank lending. Read More
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To Keep Strong Even in Bad Times, More Banks Test Themselves
For the first time, regional banking organizations with assets between $10 billion and $50 billion are required to conduct stress tests and disclose results. Read More
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The Effect of Safe Assets on Financial Fragility in a Bank-Run Model
We revisit Goldstein and Pauzner (2005) and show that, in the optimal demand-deposit contract subject to sequential service, banks hold safe assets to insure investors against investment risk, reducing the probability of a bank run. Read More
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Rebuilding after Disaster Strikes: How Local Lenders Aid in the Recovery
Using detailed employment data on firm age and size, I show that the presence of local finance improves job retention and creation at young and small firms. Read More
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The Role of Interbank Relationships and Liquidity Needs
In this paper, we focus on the interconnectedness of banks and the price they pay for liquidity. Read More
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Tracking Recent Levels of Financial Stress - October
The Cleveland Financial Stress Index (CFSI) fluctuated between grades 1 and 2 throughout the third quarter of 2014. Read More
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Regional Bank Health: Trends in Net Charge-Offs
We assess the health of regional bank loan portfolios by analyzing their net charge-off behavior over the past two years and find that their portfolios have become less risky. Read More
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Optimal Contracts, Aggregate Risk, and the Financial Accelerator
This paper derives the optimal lending contract in the financial accelerator model of Bernanke, Gertler and Gilchrist (1999). Read More
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A Gap in Regulation and the Looser Lending Standards that Followed
New research highlights how disparities in the regulatory treatment of banks and shadow banking organizations before the financial crisis allowed heavily-regulated bank holding companies to lend through their less-regulated subsidiaries. Read More
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Volatile Lending and Bank Wholesale Funding
The paper presents the first empirical study of the relation between bank loan volume volatility and bank retail and wholesale liabilities. Read More
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Interbank Lending and Distress: Observables, Unobservables, and Network Structure
We provide empirical evidence on the relevance of systemic risk through the interbank lending channel. Read More
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Filling in the Blanks: Network Structure and Interbank Contagion
This paper proposes an efficient method for estimating counterparty exposures in banking and financial markets. Read More
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Differential Capital Requirements: Leverage Ratio versus Risk-Based Capital Ratio from a Monitoring Perspective
In this paper, I attempt to amalgamate the study of leverage-ratio performance with the monitoring decisions of a profit-maximizing bank. Read More
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The Transmission of the Financial Crisis in 1907: An Empirical Investigation
Using an extensive high-frequency data set, we investigate the transmission of financial crisis specifically focusing on the Panic of 1907, the final severe panic of the National Banking Era (1863-1913). Read More
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Outside Lending in the NYC Call Loan Market
Before the Panic of 1907, large NYC banks could maintain the call loan market's liquidity during panics, but the rise in outside lending by trust companies and interior banks weakened the influence of the large banks. Read More
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Tracking Recent Levels of Financial Stress - July
The Cleveland Financial Stress Index (CFSI) remained in Grade 2 or a "normal stress" period throughout the early part of second quarter 2014. Read More
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Rising Interest Rate Risk at U.S. Banks
Average interest rate risk in the banking system has been increasing since the end of the financial crisis and is almost back to its pre-recession level. But the increase has not occurred uniformly at large and small banks. Read More
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New Rules for Credit Default Swap Trading: Can We Now Follow the Risk?
Credit default swaps were traded over the counter before the financial crisis. Reforms are being put in place which will move the majority of credit default swaps transactions to more transparent exchanges. Read More
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Tracking Recent Levels of Financial Stress - April
The Cleveland Financial Stress Index (CFSI) remained in a Grade 1 or "low stress" period throughout most of the first quarter of 2014. Read More
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Money Market Mutual Funds and Financial Stability
To assess the risk posed by money market funds to the financial system, we compare the aggregate portfolios of funds before and after the crisis and look at their liquidity positions since 2011. Read More
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Tracking Recent Levels of Financial Stress - January
The Cleveland Financial Stress Index (CFSI) has trended down throughout the fourth quarter of 2013 and early this year Read More
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Risk-Based Capital Ratios at US Banks
Capital levels offer a glimpse into the health of the banking system. Here we analyze the tier-1 risk-based capital at banks of different sizes. Read More
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Cryptography and the Economics of Supervisory Information: Balancing Transparency and Confidentiality
We elucidate the tradeoffs between transparency and confidentiality in the context of financial regulation. Read More
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Tracking Recent Levels of Financial Stress
The level of the Cleveland Financial Stress Index (CFSI) has decreased in the past few months, indicating a lower level of systemic financial stress. Read More
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Business Cycles and Financial Crises: The Roles of Credit Supply and Demand Shocks
This paper explores the hypothesis that the sources of economic and financial crises differ from those of noncrisis business cycle fluctuations. Read More
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Tracking Recent Levels of Financial Stress
The Cleveland Financial Stress Index (CFSI) has remained within a “normal stress” level since the index was revised in April 2013 Read More
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Policy in Adaptive Financial Markets—The Use of Systemic Risk Early Warning Tools
How can a systemic risk early warning system (EWS) facilitate the financial stability work of policymakers? Read More
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An Enhanced Approach to Measuring Financial Stress
The CFSI monitors stress in the overall financial system by tracking conditions in different types of financial markets. Two new markets have just been incorporated into the index, making it more sensitive to potential instability. Read More
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Tracking Recent Levels of Financial Stress
In recent months, the Cleveland Financial Stress Index (CFSI) has remained low as conditions in key financial markets continued to improve. Read More
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Financial Stress Index: A Lens for Supervising the Financial System
This paper develops a new financial stress measure (Cleveland Financial Stress Index, CFSI) that considers the supervisory objective of identifying risks to the stability of the financial system. Read More
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Who’s Afraid of Good Governance? State Fiscal Crises, Public Pension Underfunding, and the Resistance to Governance Reform
States' unfunded pension obligations to their current and retired employees have exploded in recent years to levels that are estimated to be between $750 billion and $4.4 trillion. Read More
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Tracking Recent Levels of Financial Stress
In early 2012, the Federal Reserve Bank of Cleveland began a monthly release of the Cleveland Financial Stress Index (CFSI). Read More
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The Burden of Public Debt
The overall public-debt burden of the world's most advanced countries is approaching levels not seen since the Second World War-levels that could damage their future growth prospects. Read More
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Believe Only What You See: Credit Rating Agencies, Structured Finance, and Bonds
This paper identifies rating verifiability as a key difference that explains why credit rating agencies (CRAs) failed to mitigate information asymmetries in the structured finance market but succeeded in the bond market. Read More
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Business Cycles and Financial Crises: The Roles of Credit Supply and Demand Shocks
This paper explores the hypothesis that the sources of economic and financial crises differ from those of noncrisis business cycle fluctuations. Read More
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Deep Recessions, Fast Recoveries, and Financial Crises: Evidence from the American Record
Do steep recoveries follow deep recessions? Does it matter if a credit crunch or banking panic accompanies the recession? Moreover, does it matter if the recession is associated with a housing bust? Read More
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Bank Capitalization
Over the last 20 years, the financial sector has become larger, more complex, and more interconnected. Read More
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Bank Balance Sheet Dynamics under a Regulatory Liquidity-Coverage-Ratio Constraint
This paper presents a dynamic model of a bank’s optimal choices of imposing a binding liquidity-coverage-ratio (LCR) constraint. Our baseline balance-sheet dynamics starts with portfolio separation and no LCR constraint. Read More
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The Cleveland Financial Stress Index: A Tool for Monitoring Financial Stability
To promote stability in a dynamic financial system, supervisors must monitor the system for risks at all times. Read More
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The History and Rationale for a Separate Bank Resolution Process
Everyone recognizes the need to have a credible resolution regime in place for financial companies whose failure could harm the entire financial system. Read More
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Substitution between Net and Gross Settlement Systems: A Concern for Financial Stability?
This paper studies the factors that drive the relative importance of net and gross settlement systems over the short run, using transaction volumes from countries that have had both a net and a gross settlement system at the same time. Read More
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The Financial Stress Index: Identification of Systemic Risk Conditions
This paper develops a financial stress index for the United States, the CFSI, which provides a continuous signal of financial stress and broad coverage of the areas that could indicate it. Read More
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SAFE: An Early Warning System for Systemic Banking Risk
This paper builds on existing microprudential and macroprudential early warning systems to develop a new class of models for systemic risk. Read More
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How Well Does Bankruptcy Work When Large Financial Firms Fail? Some Lessons from Lehman Brothers
We look at the Lehman example for lessons about whether bankruptcy law might be a better alternative to bailouts or to resolution under the Dodd-Frank Act's orderly liquidation authority. Read More
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Resolving Large, Complex Financial Firms
How to best manage the failure of systemically important financial firms was the theme of a conference at which the latest research on the issue was presented. Read More
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Global Banking System Exposure to the Greek Sovereign Debt Crisis
In the past year, the Greek sovereign debt crisis has been the focus of much financial press. Read More
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The Federal Reserve’s Influence Over Excess Reserves
As the economy continues to emerge from the recession, it is not yet clear how sustainable the recovery is. Read More
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An End to Too Big to Let Fail? The Dodd–Frank Act’s Orderly Liquidation Authority
One of the changes introduced by the sweeping Dodd-Frank Act is the provision of a formal process for liquidating large financial firms-something that would have been useful in 2008. Read More
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Cleaning up the Refuse from a Financial Crisis: The Case for a Resolution Management Corporation
To handle the large volume of distressed financial assets the government ends up with after systemic financial crises, I propose that the government create a temporary resolution management corporation. Read More
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Federal Home Loan Banks: The Housing GSE That Didn’t Bark in the Night?
From the onset of the financial crisis to today, Fannie Mae and Freddie Mac have frequented the financial headlines. Read More
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Stripdowns and Bankruptcy Lessons from Agricultural Bankruptcy Reform
One type of financial reform being proposed to deal with the aftermath of the housing crisis is allowing bankruptcy judges the authority to modify residential mortgages in a way referred to as a stripdown. Read More
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Banking and Financial Crises in United States History: What Guidance Can History Offer Policymakers?
This paper assesses the validity of comparisons between the current financial crisis and past crises in the United States. Read More
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Reforming the Over-the-Counter Derivatives Market: What’s to Be Gained?
While derivative financial instruments have made the hedging and exchange of risk more efficient, the recent crisis showed that they also pose a substantial threat to financial stability in times of systemic turmoil. Read More
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Systemic Risk Analysis Using Forward-Looking Distance-to-Default Series
Based on contingent claims theory, this paper develops a method to monitor systemic risk in the European banking system. Read More
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Measuring Systemic Risk
We present a simple model of systemic risk and show how each financial institution’s contribution to systemic risk can be measured and priced. Read More
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Signs of Abating Default Risk
The last recession has been so severe that firms have clearly faced a higher risk of defaulting on their liabilities. Read More
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Financial Crises and Bank Failures: A Review of Prediction Methods
In this article we provide a summary of empirical results obtained in several economics and operations research papers. Read More
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Credit Crises, Money, and Contractions: A Historical View
The relatively infrequent nature of major credit distress events makes a historical approach particularly useful. Read More
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On Systemically Important Financial Institutions and Progressive Systemic Mitigation
This paper proposes a framework for identifying and supervising systemically important financial institutions. Read More
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Financial Crises and Bank Failures: A Review of Prediction Methods
In this article we provide a summary of empirical results obtained in several economics and operations research papers. Read More
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How Realistic Were the Economic Forecasts Used in the Stress Tests?
Some observers complain that the economic forecasts used in the bank stress tests were not severe enough. Read More
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Effective Practices in Crisis Resolution and the Case of Sweden
The current financial crisis is a painful reminder that the developed world is not yet immune to these devastating shocks. Read More
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Financial Turmoil and Global Growth
The turmoil in world financial markets is impeding global economic growth, according to the International Monetary Fund (IMF). Read More
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Historical Review of Umbrella Supervision by the Board of Governors of the Federal Reserve System
The article reviews legislative history and supervisory practices related to bank holding companies with a view toward understanding what Congress meant by referring to the BOG of the FRS as the “umbrella supervisor” in the Gramm-Leach-Bliley Act. Read More
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Identifying and Resolving Financial Crises: A Conference Overview
Financial crises remain a recurring problem despite, or perhaps, as some suggest, because of, extensive innovation in capital markets over the past several decades. Read More
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Crashes and Recoveries in Illiquid Markets
We study the dynamics of liquidity provision by dealers during an asset market crash, described as a temporary negative shock to investors’ aggregate asset demand. Read More
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On the Resolution of Financial Crises: The Swedish Experience
This paper reviews the policy choices and external factors that pushed Sweden’s financial system over the edge in the late 1980s and early 1990 sand then examines the steps the government took to make its resolution of the crisis one of the most successful in the past 30 years. Read More
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Some Lessons on the Rescue of Long-Term Capital Management
This Policy Discussion Paper reviews the restructuring and recapitalization of Long-Term Capital Management, looking at possible alternatives and paying particular attention to the Federal Reserve's role. Read More
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Credit Spreads and Subordinated Debt
Stock and bond prices contain all sorts of information about investors’ beliefs and expectations. Read More
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Moral Hazard in the Diamond-Dybvig Model of Banking
We modify the Diamond-Dybvig model studied in Green and Lin to incorporate a self-interested banker who has a private record-keeping technology. Read More
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Optimal Deposit Contracts: Do-It-Yourself Bank-Run Prevention for Banks
The need for federal deposit insurance is often based on the claim that it prevents bank runs and makes the banking system more stable. Read More
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Umbrella Supervision and the Role of the Central Bank
Deregulation and financial consolidation have led to the development of financial holding companies. Read More
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Umbrella Supervision
Deregulation and financial consolidation have led to the development of financial holding companies—allowing commercial banking, insurance, investment banking, and other financial activities to be conducted under the same corporate umbrella. Read More
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Too Much Risk?
Are asset prices climbing too far too fast? Read More
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Systemic Banking Crises
Systemic banking crises can have devastating effects on the economies of developing or industrialized countries. This Policy Discussion Paper reviews the factors that weaken banking systems and make them more susceptible to crises. Read More
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Are SBA Loan Guarantees Desirable?
Over the last 10 years, the Small Business Administration has been responsible for well over $100 billion in small business credit extensions, more than any single private lender. Read More
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Getting the Most Out of a Mandatory Subordinated Debt Requirement
Recent advances in asset pricing-the reduced-form approach to pricing risky debt and derivatives-are used to quantitatively evaluate several proposals for mandatory bank issue of subordinated debt. Read More
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Monetary Policy in a Financial Crisis
What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Read More
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Who Benefits from Increasing the Federal Deposit Insurance Limit?
Who might stand to benefit from doubling the insured-deposit limit to $200,000, and are such benefits consistent with the social objectives of federal deposit insurance? Read More
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Effective Supervision and the Evolving Financial Services Industry
Technology, market consolidation, international competition, and new legislation are changing the face of the financial services industry. Read More
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On the Welfare Gains of Reducing the Likelihood of Economic Crises
The authors seek to measure the potential benefit of reducing the likelihood of economic crises (defined as Depression-style collapses of economic activity). Read More
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Two Deposit Insurance Funds Are Not Necessarily Better than One
Does the United States need to maintain two separate insurance funds for banks and thrifts? Read More
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Deposit Insurance
The Financial Modernization Act of 1999 created the most sweeping banking reforms since the Great Depression. Read More
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Raising the Deposit-Insurance Limit: A Bad Idea Whose Time Has Come?
Federal deposit insurance protects the savings of small depositors, but it increases the likelihood that banks will take risks they otherwise would not have. Read More
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Financial Crises and Market Regulation
Financial crises are inevitable. Both government intervention and market innovations can influence the frequency and severity of these episodes, but they cannot eliminate them. Read More
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Depositor-Preference Laws and the Cost of Debt Capital
Under depositor-preference laws, depositors' claims on the assets of failed depository institutions are senior to unsecured general-creditor claims. Read More
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Federal Deposit Insurance
Buoyed by the strong performance of the depository institutions sector in the mid-to-late 1990s, the Federal Deposit Insurance Corporation’s bank insurance fund (BIF) ... Read More
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Y2K Readiness
With less than 12 months to go, computer users around the world are scrambling to prepare for Year 2000. Read More
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Depositor Preference Legislation and Failed Banks' Resolution Costs
Included in the Omnibus Budget Reconciliation Act of 1993 was a provision that improved the priority of depositors and thus of the FDIC in the event of a depository institution's failure. Read More
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Consistency Conditions for Regulatory Analysis of Financial Institutions: A Comparison of Frontier Efficiency Methods
We propose a set of consistency conditions that frontier efficiency measures should meet to be most useful for regulatory analysis or other purposes. Read More
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Combining Bank Supervision and Monetary Policy
Many American organizations, from corporations to government agencies, have reengineered themselves, rethinking their businesses from the ground up. Read More
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The Impact of Depositor Preference Laws
The 1993 amendment to the Federal Deposit Insurance Corporation Act made depositors' claims on failed banks superior to those of general creditors. The legislation’s stated purpose was to reduce the cost to the FDIC of resolving bank failures. Read More
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SAIF Policy Options
As part of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989, Congress mandated a minimum coverage ratio of $1.25 of insurance reserves per $100 of insured deposits. Read More
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Similarities and Dissimilarities in the Collapses of Three State Chartered Private Deposit Insurance Funds
An analysis of the collapse of the Rhode Island Share and Deposit Indemnity Corp., focusing on distinguishing the elements of failure that it shared with other large state-chartered deposit insurance funds from those that were unique to Rhode Island. Read More
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Anticipating Bailouts: the Incentive-Conflict Model and the Collapse of the Ohio Deposit Guarantee Fund
An examination of the effect of the collapse of the Ohio Deposit Guarantee Fund on insured financial institutions in the context of the incentive-conflict model developed by Edward Kane... Read More
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Lessons from the Collapse of Three State-Chartered Private Deposit Insurance Funds
The January 1991 collapse of the Rhode Island Share and Deposit Indemnity Corporation (RISDIC) was the last in a series of post-1970 failures. Read More
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Underlying Determinants of Closed-Bank Resolution Costs
This paper looks at the underlying determinants of bank resolution costs. In the spirit of James (1991), resolution costs are modeled as functions of problem assets. Read More
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The National Depositor Preference Law
Last August 10, Congress passed the Omnibus Budget Reconciliation Act of 1993 (OBRA93). Contained in this legislation was a provision that dramatically revised the priority of claims on failed depository institutions. Read More
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Making the SAIF Safe for Taxpayers
The first concrete step toward resolving the decade-long thrift debacle was taken by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), which overhauled the federal savings and loan regulatory apparatus. Read More
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FDICIA's Emergency Liquidity Provisions
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) made a potentially significant change in the standards for Federal Reserve discount window access by nonbanks. Read More
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The Cost of Buying Time: Lessons from the Thrift Debacle
The collapse of the Federal Savings and Loan Insurance Corporation's (FSLIC) deposit insurance fund, ranks as one of the greatest financial disasters of our time. Read More
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FDICIA's Discount Window Provisions
On December 19, 1991, President Bush signed into law the Federal Deposit Insurance Corporation Improvement Act (FDIC1A), which Congress passed to address problems it saw in the supervision of federally insured banks. Read More
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History of and Rationales for the Reconstruction Finance Corporation
The creation of the Resolution Trust Corporation (RTC) in 1989, the evolution of a "too-big-to-fail" doctrine within the bank regulatory community in the 1980s... Read More
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FDICIA's Prompt Corrective Action Provisions
Following passage of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, which addressed the insolvency of the Federal Savings and Loan Insurance Corporation's deposit insurance fund. Read More
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Forbearance, Subordinated Debt, and the Cost of Capital for Insured Depository Institutions
Among the proposals intended to prevent the commercial banking industry from suffering a fate similar to that of the nation's savings and loans (S&Ls) is the requirement that banks issue subordinated debt. Read More
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Troubled Savings and Loan Institutions: Voluntary Restructuring Under Insolvency
Regulatory agencies are unwilling or unable to close thrift institutions immediately upon insolvency. Read More
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The RTC and the Escalating Costs of the Thrift Insurance Mess
Almost daily, the news media report on the ever-growing cost of resolving the savings and loan (thrift) insurance crisis. Read More
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A Proportional Hazards Model of Bank Failure: An Examination of Its Usefulness as an Early Warning Tool
Many of bank failures in recent years has created incentives for both regulators and providers of funds to identify high-risk banks accurately. One potentially cost-effective way to do this is through use of a statistical "early warning model." Read More
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Predicting Bank Failures in the 1980s
Opinions stated in Economic Review are those of the authors and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Read More
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Risk-Based Capital and Deposit Insurance Reform
Risk-based capital (RBC) is an important component of deposit insurance reform. Read More
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An Insider's View of the Political Economy of the Too-Big-to-Fail Doctrine
Understanding interbank exposure is the key to understanding the too big to fail doctrine. Read More
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Underlying Causes of Commercial Bank Failures in the 1980s
Banks failed at record rates during the past decade, and no relief appears to be in sight. Read More
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An Analysis of Bank Failures: 1984 To 1989
This paper models the regulatory decision to close a bank as a call option. Read More
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Deposit-Institution Failures: A Review of Empirical Literature
A review of the current literature on deposit-institution failures, emphasizing the various methods used to model the determinants of insolvent and failed institutions. Read More
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Economic Principles and Deposit-Insurance Reform
The current system of federal deposit insurance subsidizes risk-taking by depository institutions, resulting in increased failure-resolution costs and decreased efficiency for the entire financial system. Read More
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Modeling Large Commercial-Bank Failures: A Simultaneous-Equation Analysis
The development of a model of large-bank failures that studies insolvency and failure simultaneously and that recognizes economic, political, and bureaucratic constraints faced by regulators. Read More
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Bank Lending to LBOs: Risks and Supervisory Response
Leveraged buyouts (LBOs), a popular method of corporate restructuring in the past decade, have attracted significant attention among the news media, Congress, and bank regulators. Read More
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Bank Capital Requirements and the Riskiness of Banks: A Review
A study of the impact of capital requirements on bank portfolio decisions, showing that the variance of earnings and the incentive to increase leverage are reduced with risk- and leverage-related deposit rates... Read More
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Financial Reform at a Crossroads
Today, 75 years after the founding of the Federal Reserve System and 55 years after the nationwide bank holiday of 1933, financial regulation is once again at a crossroads. Read More
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Deposit Insurance and the Cost of Capital
The impacts of deposit insurance and forbearance on the costs and value of uninsured deposits and equity capital are shown under three regimes. Read More
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FDIC Policies for Dealing with Failed and Troubled Institutions
Bank failures reached a post- Depression high in 1986. Read More
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Seeking Safety
Investors seeking safety frequently purchase U.S. government securities. Read More
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The Use of Market Information in Pricing Deposit Insurance
An argument that information about the value of the deposit-insurance guarantee is available from market-generated data. Read More
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Equity, Efficiency, and Mispriced Deposit Guarantees
Federal deposit insurance is supposed to protect savers and to help stabilize our banking system. Read More
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Federal Reserve's Response to the Problems Experienced by ODGF Thrifts
I am pleased to appear before the Commerce, Consumer, and Monetary Affairs Subcommittee to discuss the Federal Reserve's response to the recent problems experienced by thrifts insured by the Ohio Deposit Guarantee Fund. Read More
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Deposit Rates and Local Markets
Commercial banks and thrift institutions have always competed aggressively for deposits, but in today's market they must increasingly rely on rate competition to attract depositors. Read More
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Rate Deregulation and Deposit Shifting
The deregulation of interest rates has provided increasing opportunities and choices for depository institutions and for individuals. Read More
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Working Paper Review: Stability in a Model of Staggered-Reserve Accounting
In a working paper summarized here, Michael L. Bagshaw and William T. Gavin use a simple reduced-form model of the money-supply process to investigate the nature of the dynamic process implied by staggered-reserve accounting. Read More
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Competition Between and Banks Thrift Institutions In Ohio
Technological, regulatory, and economic changes each have contributed to more intense competition between thrift institutions and commercial banks. Read More
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After Silver and Gold: Some Sober Thoughts on Speculative Bubbles
Recent months have witnessed a seeming madness in many of the world's financial markets. Following the crises in Iran and Afghanistan, investors appeared to be moving out of dollar assets and into precious metals. Read More