A Proposal for Efficiently Resolving Out-of-The-Money Swap Positions at Large Insolvent Banks
27 Pages Posted: 14 Apr 2003
Date Written: January 6, 2003
Abstract
Recent evidence suggests that bank regulators appear to be able to resolve insolvent large banks efficiently without either protecting uninsured deposits through invoking "too-big-to-fail" or causing serious harm to other banks or financial markets. But resolving swap positions at insolvent banks, particularly a bank's out-of-the-money positions, has received less attention. The FDIC can now either repudiate these contracts and treat the in-the-money counterparties as at-risk general creditors or transfer the contracts to a solvent bank. Both options have major drawbacks. Terminating contracts abruptly may result in large fire-sale losses and ignite defaults in other swap contracts. Transferring the contracts both is costly to the FDIC and protects the counterparties, who would otherwise be at-risk and monitor their banks. This paper proposes a third option that keeps the benefits of both options but eliminates the undesirable costs. It permits the contracts to be transferred, thus avoiding the potential for fire-sale losses and adverse spillover, but keeps the insolvent bank's in-the-money counterparties at-risk, thus maintaining discipline on banks by large and sophisticated creditors.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Derivatives and Systemic Risk: Netting, Collateral, and Closeout
By Robert R. Bliss and George G. Kaufman
-
Bankruptcy Law and Large Complex Financial Organizations: A Primer
-
Are Bank Holding Companies a Source of Strength to Their Banking Subsidiaries?
-
Derivatives and the Bankruptcy Code: Why the Special Treatment?
-
U.S. Corporate and Bank Insolvency Regimes: An Economic Comparison and Evaluation
By Robert R. Bliss and George G. Kaufman
-
Depositor Liquidity and Loss-Sharing in Bank Failure Resolutions
-
Netting, Financial Contracts, and Banks: The Economic Implications
By William J Bergman, Robert R. Bliss, ...