Prioritization and Mutualization: Clearinghouses and the Redundancy of the Bankruptcy Safe Harbors
This Essay argues for the repeal of the bankruptcy safe harbors for financial contracts because they are redundant systemic risk safeguards. Most systemically important types of financial contracts now clear through clearinghouses. Clearinghouses are a superior method to the safe harbors for protecting the liquidity of systemically important money substitutes and do not subordinate bankruptcy policy concerns to systemic risk concerns. Clearinghouses are a better guaranty against systemic disruption than the safe harbors because they can absorb the losses caused by insolvencies and fire sales due to their deep capital and lack of leverage. Moreover, clearinghouses reduce systemic risk by forcing internalization of systemic externalities on the finance industry through loss mutualization. This reduces the industries incentive to engage in excessively risky transactions. And, in the event that losses overwhelm clearinghouses, they are technically and politically easier to bail out than individual firm when the safe harbors prove inadequate. Accordingly, this Essay argues for the safe harbors to be replaced with a clearing mandate only for those types of highly liquid financial contracts that serve as money substitutes.
Discount Window Lending: Policy Trade-offs and the 1985 BoNY Computer Failure
On November 21, 1985, the Bank of New York (BoNY) suffered a software failure that left it unable to redeliver securities it had received from other institutions as an intermediary. The result of the failure was that the bank sought and received $22.6 billion in discount window lending from the New York Fed, a record-setting amount. The episode presents a case study for considering when discount window lending and similar interventions are justified as a matter of efficiency, as well as the need for policymakers to take account of possible moral hazard that may lead to inadequate safeguards against failures ? whether operational breakdowns or deficient financial strategies.
Bank Loan Supply Responses to Federal Reserve Emergency Liquidity Facilities
The Federal Reserve injected unprecedented liquidity into banks during the recent crisis through the discount window and Term Auction Facility. We examine the use and effectiveness of these facilities. We find that recipient banks increased their lending overall, both short- and long-term, and in most loan categories. The facilities resulted in enhanced lending at expanding banks and reduced declines at contracting banks. Small banks increased small business lending and large banks increased large business lending. There were no significant changes in loan quality or loan contract terms by either large or small banks.