Regulating in the Shadows: Systemic Moral Hazard and the Problem of the Twenty-First Century Bank Run

53 Pages Posted: 24 Feb 2012

See all articles by Zachary James Gubler

Zachary James Gubler

Arizona State University (ASU) - Sandra Day O'Connor College of Law

Date Written: January 17, 2012

Abstract

An important, emerging literature suggests that the proximate cause of the recent financial crisis was an old-fashioned bank run of the sort that was common prior to the Great Depression. But instead of individuals converging on the local savings and loan, this bank run involved investment banks’ short-term creditors who began withdrawing their cash from these banks out of concern for the quality of the underlying collateral, which consisted largely of complex asset-backed securities. A growing chorus of commentators has suggested that we should treat this run on “securitized banking” in the same way that we treated its Depression-era counterpart, including through a form of deposit insurance. In this Article, I question the reliability of this analogy by focusing on what I refer to as the “systemic moral hazard” problem posed by a deposit insurance regime for securitized banking.

This problem arises because insuring short-term creditors in this context is likely to introduce moral hazard (or increased risk-taking as the result of insurance) not only at the bank but also in the “securitization process” itself, which is the process for manufacturing the securities that these banks rely on as collateral for their short-term borrowing. Because other investors purchase these securities and may ignore or neglect their risks, the moral hazard problem of deposit insurance in this context is potentially more costly than in the traditional banking context.

This analysis gives rise to two implications. First, the systemic moral hazard problem suggests that the scope of the regulated entity under a deposit insurance regime for securitized banking would need to be much broader than the definition adopted by current banking law, which focuses regulatory oversight on the deposit-taking institution alone. However, the more expansive regulatory task implicit in this broader definition would test regulatory competence to a greater degree than in traditional banking. Consequently, the second implication of my analysis is that the systemic moral hazard problem suggests a need to consider potential policy alternatives for dealing with the twenty-first century bank run. I briefly consider three such alternatives, which focus on eliminating, limiting or circumscribing the securitized bank’s reliance on short-term debt to finance its purchase of long-term asset-backed securities.

Keywords: financial regulation, financial crisis, bank regulation, moral hazard, Dodd-Frank, deposit insurance, bank run

JEL Classification: E44, E60, G10, G20, G21, G30, K23

Suggested Citation

Gubler, Zachary James, Regulating in the Shadows: Systemic Moral Hazard and the Problem of the Twenty-First Century Bank Run (January 17, 2012). Alabama Law Review, Vol. 63, No. 2, p. 221, 2012, Available at SSRN: https://ssrn.com/abstract=2010134

Zachary James Gubler (Contact Author)

Arizona State University (ASU) - Sandra Day O'Connor College of Law ( email )

Box 877906
Tempe, AZ 85287-7906
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
181
Abstract Views
1,925
Rank
301,858
PlumX Metrics