Government Intervention in Response to the Subprime Financial Crisis: The Good into the Pot, the Bad into the Crop
32 Pages Posted: 29 Jan 2009 Last revised: 5 May 2010
Date Written: February 5, 2009
Abstract
The recent global financial crisis represents a major economic challenge. In order to prevent such market failure, it is vital to understand what caused the crisis and what are the lessons to be learned. Given the tremendous bailout packages worldwide, we discuss the role of governments as lenders of last resort. In our view, it is important not to suspend the market mechanism of bankruptcy via granting rescue packages. Only those institutions which are illiquid but solvent should be rescued, and this should occur at a significant cost for the respective institution. We provide a formal illustration of a rescue mechanism, which allows to distinguish between illiquid but solvent and insolvent banks. Furthermore, we argue that stricter regulation cannot be the sole consequence of the crisis. There appears to be a need for improved risk awareness, more sophisticated risk management and an alignment of interest among the participants in the market for credit risk.
Keywords: financial crisis, government intervention, bailout, risk management, credit risk, credit derivatives, securitization
JEL Classification: G28
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Central Bank Institutional Structure and Effective Central Banking: Cross Country Empirical Evidence
By Iftekhar Hasan and Loretta J. Mester
-
Conflicts and Financial Collapse: The Problem of Secondary-Management Agency Costs
-
Asia-Pacific Perspectives on the Financial Crisis 2007-2010
By Jonathan A. Batten, Warren P. Hogan, ...
-
The 2008-2009 Financial Crisis: Risk Model Transparency and Incentives
By Terry Marsh and Paul C. Pfleiderer
-
Valuing Illiquid Equity Securities in Light of the Financial Crisis of 2007-2009
By Niso Abuaf