Financial Intermediation: Financial Crises
Paper Session
Friday, Jan. 6, 2023 10:15 AM - 12:15 PM (CST)
- Chair: Tyler Muir, University of California-Los Angeles
Bad News Bankers: Underwriter Reputation and Contagion in Pre-1914 Sovereign Debt Markets
Abstract
This paper uses new bond-level data on sovereign borrowing and defaults during 1869-1914 to quantify a channel of contagion via banks’ reputation for monitoring borrowers. Concerns over reputation incentivized Britain’s merchant banks (who underwrote sovereign bonds) to monitor and exert influence over sovereigns. Default signaled to investors that a bank was less willing or able to write and support quality issues, indicating that its other bonds may underperform in the future. Consistent with reputation-based contagion, I find that comovement between defaulting and non-defaulting bonds is six times larger when the bonds share an underwriter. To isolate the causal effect of a shared underwriter, I exploit within-country variation in bonds’ underwriters. Testing predictions from a dynamic game where underwriters build a reputation for monitoring, I find further evidence supporting reputation as the mechanism – as opposed to alternative explanations such as wealth effects. These findings highlight that the reputation of intermediaries that monitor and intervene in crises can be a powerful source of contagion unrelated to a borrower’s fundamentals.Firm Quality Dynamics and the Slippery Slope of Credit Intervention
Abstract
In crises, low-quality firms face greater financial shortfalls and invest less than high-quality firms. Public liquidity support preserves the overall production capacity but dampens the cleansing effects of crises on firm quality. The trade-off between quantity and quality determines the optimal size of intervention. Policy distortions are self-perpetuating: A downward bias in quality necessitates interventions of greater scales in future crises. Distortions are amplified by low-quality firms’ expectations of liquidity support and overinvestment pre-crisis. Finally, the optimal intervention is larger and distortionary effects stronger in a low interest rate environment where low yields on precautionary savings discourage firms from self-insurance.Discussant(s)
Karsten Muller
,
National University of Singapore
Emil Verner
,
Massachusetts Institute of Technology
Matteo Crosignani
,
Federal Reserve Bank of New York
JEL Classifications
- G2 - Financial Institutions and Services