DP8248 Financial Black-Holes: The Interaction of Financial Regulation and Bailout Guarantees
|Author(s):||Romain Rancière, Aaron Tornell|
|Publication Date:||February 2011|
|Keyword(s):||Bailout Guarantees, Derivatives, Financial Crisis, Financial Regulation|
|JEL(s):||E22, E60, F34, G01, G18|
|Programme Areas:||International Macroeconomics, Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=8248|
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.