Crisis Management: Intended and Unintended Consequences

1. Crisis Management:Intended and Unintended Consequences Discussion by Myron L. Kwast Visiting Scholar, FDIC October 25, 2013

2. 1. Words of praise 2. Key concerns 3. Policy implications

3. Words of Praise • Address questions and issues of first order importance • Well-done empirical studies • Try to get the institutional facts right, and they mostly succeed • Careful and impressive in their collection of data • Carefully specify the hypotheses they want to test

4. Words of Praise • Implement the DID methodology in a highly competent way • Clever identification strategies • Present an impressive array of robustness checks • Pass the tests of relevance and care and therefore should be taken seriously

5. Concerns with TARP Paper 1 • Want us to believe they measure market share and market power at the local level with total assets and total costs. • But the only variable they actually have at the local level is total deposits. • Why not use local deposits shares in their “main model?”

6. Concerns with TARP Paper 2 • Lerner Index measure based on average revenues, not actual prices. • Do robustness tests using a Lerner Index computed with average revenues and average costs.

7. Bottom Line 1 • Should we believe “TARP recipients did get competitive advantages and increased both their market share and market power relative to non-TARP recipients?” • ABSOLUTELY

8. Concerns with TARP Paper 3 • Odd policy conclusion: • “Results suggest. . .any bailouts be focused primarily on small banks. . .” • Focus bailouts on small banks? • Systemic risk and financial stability have nothing to do with small banks.

9. Concerns with TARP Paper 3Bottom Line 2 • Assuming financial stability is our main concern, I want to suggest a very different policy conclusion. • One of TARP’s most serious design flaws was that it did not zero in on the banks most likely to cause financial instability. • Opened TARP to successful gaming.

10. Banks That Got Most Competitive Advantage • Recipients who repaid early • Larger banks, even those that did not repay early • Banks with higher capital ratios • Banks in highly concentrated markets

11. Concerns with OLA Paper 1 • Magdalena and Josef claim it is “simple” to compute an indicator for whether a BHC will be affected by the OLA • This is not a “simple” calculation • Key difficulty is the need to net out intra-firm assets

12. Concerns with OLA Paper 1 • Does this concern call results into question? • MAYBE NOT AND I HOPE NOT • Authors should double check their calculations, be very clear about how many firms are in their affected and unaffected groups, and list the names of the top 50 affected firms.

13. Concerns with OLA Paper 2 • Are 650 affected firms the right firms to study? • NO • OLA is specifically aimed at SIFIs • Authors should focus on a much smaller subset of “affected” firms (as in their robustness tests)

14. Concerns with OLA Paper 3 • Need to discuss and control for the increased intensity of bank supervision • The intensity of bank supervision picked up in 2009 and 2010 at non-systemic firms • This pick-up appears to have, on average, decreased bank risk

15. Concerns with OLA Paper 4 • Is the “treatment period” too soon? • MAYBE • How OLA will be implemented only began to be revealed in 2012 • All agree there is still a lot of work to do

16. Policy Implications of the OLA Paper • Most convincing results are those when they focus on potentially systemic banks • Definition of potentially systemic is reasonable • Key point: When results are confined to potentially systemic institutions their base results are reversed: rather than reducing risk, becoming subject to the OLA either has no effect or may even lead to increased risk

17. Policy Implications Cont • Magdalena and Josef conclude: • “the OLA leaves the too-big-to-fail problem unresolved” • We need to work harder at making the OLA credible for potentially systemic institutions

18. Policy Implications Cont • Should we take this policy implication seriously? • ABSOLUTELY

19. Policy Implications Cont • Real rub: Operational feasibility for one SIFI is not enough • Systemic crises always involve several SIFIs at the same time • Plus, market expectations at least as important as what the supervisors say they can do

20. Conclusion • Papers provide two really important policy takeaways • If we ever do another TARP, government capital injections should focus on banks that both pose systemic risks and that really need the injection. Opening up the program to other banks just invites undesirable gaming.

21. Conclusion Cont • For the OLA to deter systemic risk and minimize TBTF incentives, it must be considered operationally feasible and credible by market participants including potentially systemic institutions.

22. Conclusion Cont • What if we cannot meet these (or other) conditions? • It is time to seriously consider cutting potentially systemic institutions down to a size and degree of complexity where these (and possibly other) conditions can be met.

23. THE END