Understanding Living Wills
Kartik Athreya () and
Economic Quarterly, 2015, issue 3Q, 193-223
The requirement for large financial institutions to file resolution plans, or "living wills," as mandated by the Dodd-Frank Act, may mitigate the commitment problem behind TBTF. Analyzing the equilibrium of the game between banks, regulators, and debtholders, is a first step to evaluate the effect of this new policy instrument. As an alternative to regulators tying their hands so that they are not able to intervene with a bailout in the event of financial distress, living wills are meant to make the outcomes from bankruptcy better for society. This is achieved by evaluating, and guiding, choices of the firms that may improve their resolvability. If unassisted failures are more likely, in turn, debtholders who stand to lose in those failures will increase their monitoring of hard-to-regulate risk choices of the firm, further decreasing the moral hazard problem.
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