adequately acknowledge these conflicts or the patterns of they sustain. “deferential regulation” To lessen these conflicts, governments need to rethink the informational obligations that insured financial institutions and their regulators owe to taxpayers and to as de facto equity investors change the way that information on industry balance sheets and risk exposures is reported, verified, and used by supervisors. Without reforms in the practical duties imposed on industry and government officials and in the way these duties are enforced, financial safety nets will continue to expand and their expansion will undermine financial stability. 6. The TBTF guarantees are more than a form of bond insurance on outstanding debt. coverage of TBTF guarantees are richer than insurance on outstanding debt because, as long as regulators forbear from resolving its insolvency, a truly TBTF firm can acquire additional coverage simply by issuing more debt. 7. The first allows the guaranteed party Every guarantee contract has two components. to responsibility for covering losses that exceed the value of the assets of the banking put company to the guarantor. The guarantor is conceived as writing the put. But the put is not the whole contract. No guarantor wants voluntarily to expose itself to unlimited losses on a put option. For this reason, all guarantee contracts incorporate a stop-loss provision that gives the guarantor a on the assets of the firm. Ordinarily, the stop-loss kicks in just as insolvency is call approached or breached. The risk exposure a guarantor assumes from simultaneously writing a put and holding a call is the economic equivalent of an explicit equity position. Efforts to exercise the call are termed prompt corrective action. We did government’s not see much prompt action for TBTF institutions during the Great Financial Crisis of corrective
adequately acknowledge these conflicts or the patterns of “deferential regulation” they sustain. To lessen these conflicts, governments need to rethink the informational obligations that insured financial institutions and their regulators owe to taxpayers as de facto equity investors and to change the way that information on industry balance sheets and risk exposures is reported, verified, and used by supervisors. Without reforms in the practical duties imposed on industry and government officials and in the way these duties are enforced, financial safety nets will continue to expand and their expansion will undermine financial stability. 6. TBTF guarantees are more than a form of bond insurance on outstanding debt. The coverage of TBTF guarantees are richer than insurance on outstanding debt because, as long as regulators forbear from resolving its insolvency, a truly TBTF firm can acquire additional coverage simply by issuing more debt. 7. Every guarantee contract has two components. The first allows the guaranteed party to put responsibility for covering losses that exceed the value of the assets of the banking company to the guarantor. The guarantor is conceived as writing the put. But the put is not the whole contract. No guarantor wants voluntarily to expose itself to unlimited losses on a put option. For this reason, all guarantee contracts incorporate a stop-loss provision that gives the guarantor a call on the assets of the firm. Ordinarily, the stop-loss kicks in just as insolvency is approached or breached. The risk exposure a guarantor assumes from simultaneously writing a put and holding a call is the economic equivalent of an explicit equity position. Efforts to exercise the government’s call are termed prompt corrective action. We did not see much prompt corrective action for TBTF institutions during the Great Financial Crisis of