Contingent Capital and Bank Risk-Taking among British Banks before World War I

The recent financial turmoil highlights the incentive of highly leveraged financial institutions to take excessive risk, given the protection of limited liability. During the nineteenth and early twentieth century, many banks operated under liability rules which obligated shareholders to bear larger costs of bank insolvency in the form of contingent, or even unlimited liability. This paper examines the empirical relationship between the size of banks’ contingent liability and their risk-taking behavior using data on British banks from 1878-1912. We find that banks with more contingent liability appear to have taken less risk. We also find evidence that the risk-reducing effects of contingent liability were larger for banks with higher leverage, suggesting that contingent capital mitigated moral hazard problem at banks.Contingent Capital, Bank Risk-Taking, British Banks

International Aspects of the Great Depression and the Crisis of 2007: Similarities, Differences, and Lessons

We focus on two international aspects of the Great Depression--financial crises and international trade—and try to discern lessons for the current economic crisis. Both downturns featured global banking crises which were generated by boom-slump macroeconomic cycles. During both crises, world trade collapsed faster than world incomes and the trade decline was highly synchronized across countries. In the Depression, income losses and rises in trade barriers explain trade’s collapse. Due to vertical specialization and more intense trade in durables today’s trade collapse is due to uncertainty and small shocks to trade costs hitting international supply chains. So far, the global economy has avoided the global trade wars and banking collapses of the Depression perhaps due to improved policy. Even so, the global economy remains susceptible to large shocks due to financial innovation and technological change as recent events illustrate.Great Depression, Crisis of 2007

In case you missed it … six notable economic stories from 2013

Last year was a busy one, not least in the area of economics. Richard S. Grossman takes us through the most notable economics stories of 2013, including a mixed performance for the US economy, Janet Yellen’s replacement of Ben Bernanke as Chairman of the Federal Reserce system, and the rise of “Abenomics” in Japan

Political betting markets, like the now defunct Intrade, can provide important insights into campaigns

In this year’s midterm elections, those interested in campaigns had a seemingly vast array of polls and predictions to choose from. Richard S. Grossman argues that political betting markets can also have a role to play in providing information about election campaigns. Using the now closed Intrade.com prediction market as an example, he argues that such markets can provide important summaries that apply financial market mechanisms to politics for those interested in campaigns

International Aspects of the Great Depression and the Crisis of 2007: Similarities, Differences, and Lessons

We focus on two international aspects of the Great Depression—financial crises and international trade— and try to discern lessons for the current economic crisis. Both downturns featured global banking crises which were generated by boom-slump macroeconomic cycles. During both crises, world trade collapsed faster than world incomes and the trade decline was highly synchronized across countries. In the Depression, income losses and rises in trade barriers explain trade's collapse. Due to vertical specialization and more intense trade in durables, today's trade collapse is due to uncertainty and small shocks to trade costs hitting international supply chains. So far, the global economy has avoided the global trade wars and banking collapses of the Depression perhaps due to improved policy. Even so, the global economy remains susceptible to large shocks due to financial innovation and technological change as recent events illustrate.

Assessing Damages: The 1983 Israeli Bank Shares Crisis

In 1983 Israeli bank shares collapsed following several years during which the bank had actively intervened to promote share prices and thereby contributed to a 300% rise in real terms. During the crisis the government assumed control of the banks, which they did not begin to sell back to the public until 1993. We compare 1993 bank share prices after the banks were partially re-listed on the stock market values were$10 billion lower than in 1983, a decline born by pre-crisis shareholders ($4 billion) and by taxpayers ($6 billion). Of this latter amount, two-thirds represent a transfer from the government to the shareholders, while approximately one-third represents an efficiency loss- and hence a direct cost- resulting from government ownership of the banks for 10 years following the crisis. The results highlight the risk inherent in a banking system that is both concentrated and universal and illustrates the costs associated with sustained government ownership