Working Paper: CEPR ID: DP8248
Authors: Romain Rancière; Aaron Tornell
Abstract: This paper argues that the U.S. financial crisis is a new type of crisis: a "financial black hole." Financial black holes are characterized by the breaking-up of credit market discipline and the large-scale financing of negative NPV projects. In a theoretical model, we explain how the combination of perceived government guarantees and the ability to issues catastrophe-bond-like liabilities generate financial black holes. We then show that the stylized facts of the U.S. economy are consistent with a financial black hole equilbrium.
Keywords: bailout guarantees; derivatives; financial crisis; financial regulation
JEL Codes: E22; E60; F34; G01; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perceived government guarantees (H81) | issuance of catastrophe bond-like liabilities (G33) |
| issuance of catastrophe bond-like liabilities (G33) | breakdown of financial discipline (G28) |
| breakdown of financial discipline (G28) | funding of negative NPV projects (G32) |
| removal of regulatory restrictions on catastrophe bonds (G18) | collapse of financial discipline (F65) |
| collapse of financial discipline (F65) | over-leveraging of safe entrepreneurs (L26) |
| proliferation of financing instruments (O16) | emergence of financial black hole (F65) |
| market share of private securitizers (G24) | emergence of financial black hole (F65) |
| pricing of financial instruments with catastrophic risk (G13) | presence of systemic bailout guarantees (H81) |
| increase in share of mortgages likely to have negative NPV (G21) | emergence of financial black hole (F65) |