Berry K. Wilson

An Analysis of Bank Charter Value and Its Risk-Constraining Incentives

Valuable bank charters have been hypothesized to provide bank managers self-regulatory incentives to constrain their risk taking. However, this paper presents evidence that charter value itself may derive from high-risk activities, indicating that minimizing risk taking also would limit the value of the charter. During economic expansions, bank charter values increase to reflect growth opportunities. In turn, high-charter-value banks gain easier access to equity capital sources for expansion. The result is a positive relationship between charter value and capital ratios during expansions. However, this relationship may invert during economic contractions. Panel regressions demonstrate that the charter value and bank leverage relationship is sensitive to market conditions.

The impact of consolidation and safety-net support on Canadian, US and UK banks: 1893–1992

Abstract This study investigates bank consolidation and safety-net support provision in Canada, the UK and the US over a 100-year historical period, and the impact of these policy variables on bank capital and risk-taking choices. The study finds that consolidation and strengthened safety nets have largely supplanted the historical role of high bank capital levels in providing protection to risk-adverse depositors. Furthermore, despite strengthened safety-net guarantees, the study finds that bank asset-risk choices in the 1980s are comparable to those observed in the 1890s, while bank equity volatilities have shown approximately a 10-fold increase over this period. Finally, the study finds that bank capital ratios are as asset-risk sensitive in the 1980s as those in the 1890s, perhaps reflecting residual market discipline or regulatory moral-suasion effects.

Financial fragility and Mexico's 1994 peso crisis: an event-window analysis of market-valuation effects

Persistent cycles of devaluation, debt repudiation, and financial crisis have been recurrent themes in Latin America and elsewhere. This study focuses on one such event, namely, the Mexican peso devaluation, debt, and financial-sector crisis of 1994-95. This paper utilizes an event-study framework, with daily stock market data, to document financial market responses to the unfolding crisis. In particular, we find that the devaluation itself was viewed as relatively benign by market participants. The results also show little evidence that investors anticipated the peso devaluation, the declining reserve levels of Mexicos central bank, and the increasing sovereign default risk of Mexico. However, the results suggest that the equity markets did respond positively to remedial actions taken by governmental authorities, such as the Clinton bailout plan.

A Contracting-Theory Interpretation of the Origins of Federal Deposit Insurance

Conventional wisdom holds that the enactment of federal deposit insurance helped small rural banks at the expense of large urban institutions. This paper uses asymmetric information, agency-cost paradigms from corporate finance theory and data on bank stock prices to show how deposit insurance could and did help stockholders of large banks. The broadening stockholder distribution of large banks during the stock market bubble of the late 1920s undermined the efficiency of double liability provisions in controlling incentive conflict among large bank stakeholders. Federal deposit insurance restored depositor confidence by asking government officials to take over and bond the task of monitoring managerial performance and solvency at U.S. banks.

Regression evidence of safety-net support in Canada and the U.S., 1893-1992

Abstract Using annual deviations between the stock market and accounting valuations of major banks, this paper constructs synthetic century-long time series for the intangible safety-net capital generated by reporting and supervisory policies in Canada and the U.S. The credibility of the modeling exercise that produces these synthetic time series is supported by evidence that, in each country, all sustained surges in the value of estimated safety-net capital correlate in appropriate ways with regulatory events and crisis pressures. We invite others to test the qualitative usefulness of our framework by applying the method to data from other countries.

On the information content of ratings: an analysis of the origin of Moody's stock and bond ratings

John Moody published his first railroad security analysis and ratings manual in April 1909. This study analyzes several current issues by looking back at Moodys original intentions for constructing a ratings system. The study analyzes whether Moody intended his ratings to reflect his private information, or rather, to serve some alternative role, as with monitoring conflicts of interests or realizing informational economies of scale. The study uses an ordinal regression approach to evaluate a set of explanatory variables, constructed from both the manual itself and the panic months of 1907, to test the potential information content of Moodys ratings. At the time of Moodys first rating system, the illiquidity of the US Treasury market forced investors to seek alternative ‘high-quality’ securities. Indeed, Moody rated 38.94 percent of railroad bonds as Aaa, and rated 85.25 percent of railroad bonds as A, Aa or Aaa in his universe of railroad bonds rated. To further test the informational content of Moodys ratings, the study pursues a structural default analysis during the panic year of 1907, which yields results that indicate that the default risk of railroad securities was quite low at the time. These results provide justification for the high overall ratings that Moody assigned to railroad securities, and thus their role as near risk-free securities. Therefore, railroad securities, and Moodys ratings, played a particularly important role in the financial system at the time.

Contingent Liability in Banking: Useful Policy for Developing Countries?

Bank owner contingent liability has been important in the development of many industrial countries. Unlimited liability on bank owners was an important element in the success of Scottish banking, which led Scotland to be free of the banking and monetary upheavals that occurred in Britain and the United States. The unlimited liability provision effectively minimized the losses suffered by bank noteholders and other creditors. Three factors were vital to the success of unlimited liability in Scotland: 1) the identities of bank owners were made publicly available, and their level of wealth could be verified; 2) under Scottish bankruptcy law, owner liability extended to both personal and inheritable wealth; and 3) the transfer of ownership claims in private and provincial banks required that ownership first be dissolved before a new bank could be formed. A contingent liability system has three advantages: 1) because double liability imposes postclosure losses on bank stockholders, it increases incentives for banks to hold capital and decreases moral hazard incentives; 2) a contingent liability system can ameliorate asymmetric information problems between bank creditors and owners; and 3) contingent liability can lead to more efficient capital formation if potential capital sources are predominantly in the form of fixed wealth, as is true in many developing countries. But a free-rider problem arises when less-wealthy stockholders rely on the monitoring efforts of wealthier stockholders, who have more incentive to monitor. And in a free and anonymous exchange market, investors with less personal fixed wealth will outbid those with greater wealth, so the value of double liability could collapse overtime.

Deflation and Reflation: The Pre-WW I Impact on NYSE Trading Volumes and Seat Prices

The study analyzes a unique time period of sustained deflation from 1867 to 1896, followed by sustained reflation after 1896. We use these periods to test two hypotheses concerning the impact on NYSE trading volumes and seat prices. The first is the “liquidity-trading” hypothesis, which hypothesizes that liquidity trading, a component of total trading volume, is positively correlated with interest rates. The second is the price-volume relationship, which hypothesizes a positive relationship between stock prices returns and changes in trading volume. These hypotheses suggest that NYSE trading volume should fall (rise) with falling (rising) stock prices and interest rates. We find strong support for both hypotheses, and additionally show that the impact of stock market prices on trading volumes is highly asymmetrical. As well, the study argues and finds evidence that the high level of systematic risk found in the pricing of NYSE seats is another reflection of the price-volume relationship. Therefore, the study finds strong evidence of a link between deflation, reflation and market liquidity as reflected in trading volumes and the pricing of NYSE seats.