This study investigates whether the implementation of the European bail-in regime effectively mitigates or eliminates implicit government guarantees (IGG) within the European banking sector. Following the global financial crisis, IGG—defined as the market’s expectation of state support for systemically important banks—became a key policy concern due to its distortionary effects on risk-taking, funding costs, and sovereign stability. The research aims to empirically assess whether the post-crisis regulatory shift toward creditor bail-in mechanisms has reduced the perceived likelihood of government intervention in bank failures. The analysis begins with a comprehensive review of the theoretical and empirical literature on IGG, outlining its definition, economic consequences, and valuation methodologies. The review identifies core determinants of IGG, such as bank size, interconnectedness, and systemic relevance, and contrasts traditional funding advantage and contingent claim approaches for its measurement. Particular attention is paid to the link between IGG and systemic risk propagation via the sovereign-bank “doom loop.” Subsequently, a comparative overview of measurement techniques is presented, synthesizing key empirical studies that quantify IGG through credit default swap (CDS) spreads, bond yield differentials, and rating-based indicators. The methodological discussion highlights the strengths and limitations of each approach and establishes the empirical framework for the present study. The central empirical analysis evaluates the European bail-in regulation as a structural reform designed to internalize bank losses and break the expectation of government rescues. Using an event study methodology and Seemingly Unrelated Regressions (SUR) to estimate abnormal stock returns around key regulatory announcements between 2010 and 2020, the study examines how financial markets reassessed the risk profile of European banks in response to bail-in policy developments.
IMPLICIT GOVERNMENT GUARANTEES. A LITERATURE REVIEW
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large financial institutions, including banks and non-banks, that encountered difficulties were bailed out,11 i.e., they received support from the government. Arguably, this government support may have been needed to avoid financial contagion within a closely interconnected banking system, but there is an inherent risk of moral hazard when financial institutions and their shareholders can expect to be bailed out by governments using public funds. Moreover, in the Euro area, the 2008 bailout caused what became the nexus of the crisis: the fatal doom loop between bank and sovereign creditworthiness (e.g., Acharya et al., 2014). This chapter reviews extant literature on IGGs and provides an overview of IGG valuation approaches, which serve as a foundation for the discussion of different methods for measuring IGGs in Chapter 3. 2.2 ACKNOWLEDGMENT AND DEFINITION OF IGG Implicit government guarantees (IGGs) are defined as guarantees that are not yet on a bank or government balance sheet and whose value is not disclosed. A variety of studies associate IGGs with political discourse, including evidence that supports and implicitly acknowledges the existence of IGGs and their mechanisms, including the transfer of loss to taxpayers. During the global financial crisis, most bailed out banks resolved their liquidity issues using emergency funds provided by national governments, thus transferring losses in that amount to taxpayers (Bordo and James, 2014). De Grauwe (2011) finds that in most countries, taxpayers are expected to cover the cost of authorized bailouts in certain crisis circumstances, while financial administrators are seldom held responsible for their role in loss-causing activities during a financial crisis. De Grauwe
Lehman $138 Billion after Bankruptcy,” by Tiffany Kary and Chris Scinta, Bloomberg News, November 11, 2011; “Lehman Brothers files for bankruptcy”, Financial Times, September 16, 2008). 11 This led, among others, to a substantial disbursement for many governments and threatened the solvency of various European countries, such as Ireland and Spain.
EVIDENCE FROM THE EUROPEAN BAIL-IN REGIME. AN EMPIRICAL ANALYSIS
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led to the global financial crisis of 2007 and renewed debate over government intervention in the financial sector (e.g., Barth and Seckinger, 2018; Moenninghoff et al., 2015). During this crisis, implicit guarantees were made explicit.24 With the exception of Lehman Brothers,25 all large financial institutions, including banks and non-banks, that encountered difficulties were bailed out,26 i.e., they received support by the government. Arguably, this government support may have been needed to avoid financial contagion within a closely interconnected banking system, but there is an inherent risk of moral hazard when financial institutions and their shareholders can expect to be bailed out by governments using public funds. Moreover, in the Euro area, the 2008 bailout caused what became the nexus of the crisis: the fatal doom loop between bank and sovereign creditworthiness (e.g., Acharya et al., 2014). In response to the financial crisis, international regulatory bodies developed new mandatory regulatory measures consisting of enhanced supervision, capital surcharges, and the establishment of resolution regimes specifically for banks that would pose high risks to the financial system if they were to fail.27 In Europe, where most countries lacked a resolution framework before the crisis, policymakers designed a completely new regulatory framework. In addition, the EU established the Banking Union, which contains three pillars: the Single Supervisory Mechanism (SSM), the Single Resolution Mechanism (SRM), and a planned common 24 The use of public funds in this sector increased dramatically between 2008 and 2013. The interventions took various forms, ranging from recapitalization to loans and explicit government guarantees. 25 Lehman Brothers
Testimony of Chairman Alan Greenspan Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate February 24, 2004 ← Testimony of Chairman Alan Greenspan Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate by Alan Greenspan → sister projects : Wikidata item February 24, 2004 258126 Testimony of Chairman Alan Greenspan Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate Alan Greenspan Mr. Chairman, Senator Sarbanes, and Members of the Committee: Thank you for inviting me to discuss the role of housing-related government-sponsored enterprises (GSEs) in our economy. These GSEs--the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Banks (FHLBs)--collectively dominate the financing of residential housing in the United States. Indeed, these entities have grown to be among the largest financial institutions in the United States, and they now stand behind more than $4 trillion of mortgages--or more than three-quarters of the single-family mortgages in the United States--either by holding the mortgage-related assets directly or assuming their credit risk. [ 1 ] Given their ties to the government and the consequent private market subsidized debt that they issue, it is little wonder that these GSEs have come under increased scrutiny as their competitive presence in the marketplace has increased. In my remarks, I will not focus on the Federal Home
Indeed, in the United States, more than $2 trillion of securitized assets currently exists with no government guarantee, either explicit or implicit. * * * Given their history of innovation in mortgage-backed securities, why do Fannie and Freddie now generate such substantial concern? The unease relates mainly to the scale and growth of the mortgage-related asset portfolios held on their balance sheets. That growth has been facilitated, as least in part, by a perceived special advantage of these institutions that keeps normal market restraints from being fully effective.
The GSEs' special advantage arises because, despite the explicit statement on the prospectus to GSE debentures that they are not backed by the full faith and credit of the U.S. government, most investors have apparently concluded that during a crisis the federal government will prevent the GSEs from defaulting on their debt. An implicit guarantee is thus created not by the Congress but by the willingness of investors to accept a lower rate of interest on GSE debt than they would otherwise require in the absence of federal sponsorship.
Importantly, the scale itself has reinforced investors' perceptions that, in the event of a crisis involving Fannie and Freddie, policymakers would have little alternative than to have the taxpayers explicitly stand behind the GSE debt. This view is widespread in the marketplace despite the privatization of Fannie and Freddie and their control by private shareholders, because these institutions continue to have government missions, a line of credit with the Treasury, and other government benefits, which confer upon them a special status in the eyes of many investors.
The part of Fannie's and Freddie's purchases from mortgage originators that they do not fund themselves, but instead securitize, guarantee, and sell into the market, is a somewhat different business. The value of the guarantee is a function of the expectation that Fannie and Freddie will not be allowed to fail. While the rate of return reflects the implicit subsidy, a smaller amount of Fannie's and Freddie's overall profit comes from securitizing and selling mortgage-backed securities (MBS). * * * Fannie's and Freddie's persistently higher rates of return for bearing the relatively low credit risks associated with conforming mortgages is evidence of a significant implicit subsidy.
A recent study by a Federal Reserve economist, Wayne Passmore, attempts to quantify the value of that implicit subsidy to the private shareholders of Fannie and Freddie. His research indicates that it may account for more than half of the stock market capitalization of these institutions. The study also suggests that these institutions pass little of the benefit of their government-sponsored status to homeowners in the form of lower mortgage rates. Passmore's analysis suggests that Fannie and Freddie likely lower mortgage rates less than 16 basis points, with a best estimate centering on about 7 basis points.
If the estimated 7 basis points is correct, the associated present value of homeowner savings is only about half the after-tax subsidy that shareholders of these GSEs are estimated to receive. Congressional Budget Office and other estimates differ, but they come to the essentially same conclusion: A substantial portion of these GSEs' implicit subsidy accrues to GSE shareholders in the form of increased dividends and stock market value. Fannie and Freddie, as you know, have disputed the conclusions of many of these studies. As noted by the General Accounting Office, the task of assessing the costs and benefits associated with the GSEs is difficult.
The size of Fannie and Freddie, the complexity of their financial operations, and the general indifference of many investors to the financial condition of the GSEs because of their perceived special relationship to the government suggest that the GSE regulator must have authority similar to that of the banking regulators. In addressing the role of a new GSE regulator, the Congress needs to clarify the circumstances under which a GSE can become insolvent and, in particular, the resultant position--both during and after insolvency--of the investors that hold GSE debt.
They have made, and should--with less reliance on subsidies--continue to make, major contributions to the financial system of the United States. * * * In sum, the Congress needs to create a GSE regulator with authority on a par with that of banking regulators,
Everything we examined (2)
This check searched the claim as stated. It did not run a separate search for evidence against it.