PDFDownload paper RWP 19-10, November 2019

This paper examines an episode when policy response to a financial crisis effectively incentivized financial institutions to reallocate their portfolios toward safe assets. Following a shift to a regime of enhanced regulation and scaled-down public assistance during the savings and loan crisis in 1989, I find that thrifts with a high probability of failure increased their composition of safe assets relative to thrifts with a low probability of failure. The findings also show a shift to safe assets among stock thrifts relative to mutual thrifts, thereby providing evidence of risk-shifting from equity-holders to debt-holders of stock thrifts prior to the regulatory reforms. These findings suggest that for recent policies aimed at reducing moral hazard to succeed (such as the Orderly Liquidation Authority under Title II of the Dodd-Frank Act), credible signals around government assistance should be provided to shareholders of financial institutions. To identify the effect of the policy change I develop a new Bayesian estimation method for causal studies.

JEL Classification: C11, C31, C33, G21, G33, G38

Article Citation

Author

Padma Sharma

Economist

Padma Sharma is an Economist at the Federal Reserve Bank of Kansas City. She joined the Economic Research Department in July 2019. Prior to joining the department, she completed …