Financial Safety Nets: The Good, the Bad, and the Ugly

Abstract

This paper focuses on the adverse long-run and distributional effects of stealthy zero-haircut rescues of US and EU mega-banks by central bankers during the Great Financial Crisis and its aftermath. It explores movements in the crisis and post-crisis behavior of credit spreads at a sample of US and EU mega-banks and develops a method for determining the extent to which the debt of individual firms is or is not trading principally on the taxpayers’ dime. This analysis indicates that creditors remain unpersuaded by post-crisis reforms meant to signal an end to too-big-to-fail policy commitments and see these reforms instead as half-measures that do not change the underlying incentive structure under which mega-banks and their regulators operate.

Keywords: too big to fail banks, financial crisis, financial reform, European bank crisis

JEL Classification: G18, F65, E58, F38