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TARP and Market Discipline: Evidence on the Moral Hazard Effects of Bank Recapitalizations

Forssbaeck, Jens LU and Nielsen, Caren Yinxia LU (2016) In Working Papers
Abstract
We examine the moral hazard effects of bank recapitalizations by assessing the impact of the U.S. TARP program on market discipline exerted by subordinated debt-holders using a sample of 123 bank holding companies over the period 2004-2013. Predicted distress risk has a consistently positive and significant effect on sub-debt spreads, suggesting the presence of market discipline. A higher bailout probability significantly reduces the risk-sensitivity of spreads for the full sample, indicating a moral hazard effect of recapitalizations. This appears to be a too-big-to-fail effect, as it is absent when the largest banks are dropped from the sample. Results indicate that it is transitory. We also find a large effect of the crisis, appearing... (More)
We examine the moral hazard effects of bank recapitalizations by assessing the impact of the U.S. TARP program on market discipline exerted by subordinated debt-holders using a sample of 123 bank holding companies over the period 2004-2013. Predicted distress risk has a consistently positive and significant effect on sub-debt spreads, suggesting the presence of market discipline. A higher bailout probability significantly reduces the risk-sensitivity of spreads for the full sample, indicating a moral hazard effect of recapitalizations. This appears to be a too-big-to-fail effect, as it is absent when the largest banks are dropped from the sample. Results indicate that it is transitory. We also find a large effect of the crisis, appearing both as a uniform rise in, and a heightened risk sensitivity of, sub-debt spreads during the crisis. (Less)
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author
and
organization
publishing date
type
Working paper/Preprint
publication status
published
subject
keywords
Bank bailouts, moral hazard, distress risk, capital injections, TARP, CPP, market discipline, financial crisis, E50, G01, G21, G28, H12
in
Working Papers
issue
2016:10
pages
49 pages
language
English
LU publication?
yes
id
28d093d9-94ca-4a56-8803-5c87923a1936
date added to LUP
2016-06-15 11:30:54
date last changed
2025-04-04 14:02:55
@misc{28d093d9-94ca-4a56-8803-5c87923a1936,
  abstract     = {{We examine the moral hazard effects of bank recapitalizations by assessing the impact of the U.S. TARP program on market discipline exerted by subordinated debt-holders using a sample of 123 bank holding companies over the period 2004-2013. Predicted distress risk has a consistently positive and significant effect on sub-debt spreads, suggesting the presence of market discipline. A higher bailout probability significantly reduces the risk-sensitivity of spreads for the full sample, indicating a moral hazard effect of recapitalizations. This appears to be a too-big-to-fail effect, as it is absent when the largest banks are dropped from the sample. Results indicate that it is transitory. We also find a large effect of the crisis, appearing both as a uniform rise in, and a heightened risk sensitivity of, sub-debt spreads during the crisis.}},
  author       = {{Forssbaeck, Jens and Nielsen, Caren Yinxia}},
  keywords     = {{Bank bailouts; moral hazard; distress risk; capital injections; TARP; CPP; market discipline; financial crisis; E50; G01; G21; G28; H12}},
  language     = {{eng}},
  note         = {{Working Paper}},
  number       = {{2016:10}},
  series       = {{Working Papers}},
  title        = {{TARP and Market Discipline: Evidence on the Moral Hazard Effects of Bank Recapitalizations}},
  url          = {{https://lup.lub.lu.se/search/files/194593401/WP16_10.pdf}},
  year         = {{2016}},
}