October 5, 2020

Quietly preventing a bank run

Should policymakers maintain anonymity for financial institutions who need a bailout during a crisis?

Chris Fleisher

Federal Reserve Chairman Ben S. Bernanke and former Chairman Alan Greenspan talk before the start of the Federal Reserve System's Centennial Commemoration in Washington, D.C., held on December 16, 2013.

Federal Reserve

At the height of the Great Recession, fiscal policymakers had a $700 billion plan to help struggling banks. 

The Troubled Asset Relief Program would purchase the toxic assets from weak financial institutions, swapping them out for healthy government bonds. 

But the participating banks had to be anonymous. There was a stigma to needing a federal bailout. Accepting TARP funds could signal to depositors that the bank was in trouble, potentially sparking a run.

“Releasing the names of [the borrowing] institutions in real-time, in the midst of the financial crisis, would have undermined the effectiveness of the emergency lending and the confidence of investors and borrowers,” then Fed-Chair Ben Bernanke said in 2009.

In the American Economic Journal: Macroeconomics, authors Gary Gorton and Guillermo Ordoñez investigate the role that information plays in restoring confidence during a crisis and offer a model that they say is more applicable to designing bailout packages in our globalized financial system. 

Rather than taking the standard view of financial panics, in which investors are worried about the quality of their bank’s assets and rush to withdraw their money, the authors focused on how information itself can lead to a bank run and what that means for maintaining secrecy. 

“In our setting each individual depositor is afraid of the unknown quality of its own piece of collateral, without concerns to what other depositors do, which is more consistent with the modern financial landscape in which large institutional investors ‘deposit’ through repo markets,” Ordoñez said in an email interview with the AEA. “Given this view, the source of the crisis is information about collateral, and public lending facilities should be designed to discourage such information.”

In other words, they say their interpretation of a run is not one in which a depositor shouts “give me the money!” but rather says “show me the money!”

Traditionally, the rationale for keeping bailouts anonymous was to avoid stigmatizing the institutions being helped. That secrecy would encourage distressed banks to participate. Otherwise, the stigma of needing a bailout would lead banks to inefficiently avoid being rescued, which would put their portfolios and depositors at risk.

Gorton and Ordoñez flip this. 

Without stigma, pretty much all banks would seek funds and maybe even disclose their participation, because showing they have public funds would relax pressures for their private assets to be investigated. Central bankers could discourage healthy banks from participating by making it more expensive (by raising the cost to swap private assets for government bonds), but the banks still may want to publicize their participation. 

For us, secrecy is the end, not the means, of lending facilities.

Guillermo Ordoñez

What stops them? Stigma. Even if participating in the program signaled that their collateral was better amid the crisis, the stigma of accepting help suggested that they were not among the best-positioned banks. 

 “For us, secrecy is the end, not the means, of lending facilities,” Ordoñez said. 

The authors say the optimal policy would be one of opacity, allowing weak or insolvent banks to seek government assistance anonymously.

In the real world, though, secrecy may not be possible. Political pressure for transparency and accountability may overwhelm the central bank’s desire for opacity.

That’s what happened in 2009. Despite Bernanke’s desire to maintain the secrecy of TARP borrowers, press outlets and politicians pressed to reveal the names of institutions. The Senate Congressional Oversight Panel ultimately required information on participating banks to be public. 

Ordoñez said they’re not oblivious to the challenges that secrecy poses. It may very well incentivize banks and politicians to behave badly. Banks might take riskier bets and politicians could push for more discretionary use of public funds if they knew nobody would ever find out. Still, that doesn’t totally settle the issue. 

“The challenge is not to introduce inefficient transparency,” Ordoñez said, “but instead to curb those misaligned incentives.” 

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“Fighting Crises with Secrecy” appears in the October issue of the American Economic Journal: Macroeconomics.