Failed Bank Resolution and the Collateral Crunch: The Advantages of Adopting Transferable Puts
Revised article published in AREUEA 22, no. 1 (Spring 1994): 135-147.
Current methods of failed bank resolution are unnecessarily expensive for taxpayers and impose substantial costs on borrowers at failed banks. This situation is due to distorted incentives imbedded in the standard contract between the government and acquirers of failed banks, which result in more loan foreclosures than if the loan were held by a well-capitalized bank. This paper proposes a modification to the standard contract in the form of a transferable put, which would introduce market-based incentives to the disposition of failed bank assets.