Discussion paper

DP8248 Financial Black-Holes: The Interaction of Financial Regulation and Bailout Guarantees

This paper argues that the U.S. financial crisis is a new type of crisis: a "financial black hole." Financial black holes are characterized by the breaking-up of credit market discipline and the large-scale financing of negative NPV projects. In a theoretical model, we explain how the combination of perceived government guarantees and the ability to issues catastrophe-bond-like liabilities generate financial black holes. We then show that the stylized facts of the U.S. economy are consistent with a financial black hole equilbrium.

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Citation

Tornell, A and R Ranciere (2011), ‘DP8248 Financial Black-Holes: The Interaction of Financial Regulation and Bailout Guarantees‘, CEPR Discussion Paper No. 8248. CEPR Press, Paris & London. https://cepr.org/publications/dp8248