This paper examines the implications that alternative regulatory structures may have for resolving failed banking institutions. Emphasis on the European Union (EU), which is both economically and financially large and has several features relating to cross-border banking in the form of direct investment that may heighten the problems we consider. To ensure the efficient resolution of bank failures with minimum, if any, credit and liquidity losses a four step program should be followed. This includes prompt legal closure of institutions before they become economically insolvent, prompt identification of claims and assignment of losses, prompt reopening of failed institutions, and prompt re-capitalizing and re-privatization of failed institutions. These policies together with a prompt corrective action system could be voluntarily adopted through the use of deposit insurance premium discounts as an incentive.

In the U.S., as in most countries with well-developed securities markets, derivative securities enjoy special protections under insolvency resolution laws. Most creditors are “stayed” from enforcing their rights while a firm is in bankruptcy. However, many derivatives contracts are exempt from these stays. Furthermore, derivatives enjoy netting and closeout, or termination, privileges which are not always available to most other creditors. The primary argument used to motivate passage of legislation granting these extraordinary protections is that derivatives markets are a major source of systemic risk in financial markets and that netting and closeout reduce this risk. To date, these assertions have not been subjected to rigorous economic scrutiny. This paper critically re-examines this hypothesis. These relationships are more complex than often perceived. We conclude that it is not clear whether netting, collateral, and/or closeout lead to reduced systemic risk, once the impact of these protections on the size and structure of the derivatives market has been taken into account.

In recent years, a number of studies have been published evaluating alternative bond portfolio strategies. These studies basically simulate risk-return characteristics for a variety of strategies designed for use by financial institutions. Typical strategies considered include portfolios of bonds that have laddered or barbell (dumbbell) maturity structures. In laddered strategies, bonds are spaced evenly among a number of consecutive maturities, while in barbell strategies, bonds are concentrated in short and long maturities. The results of these studies tend to differ and conflict. For example, in a recent article in this journal, Fogler, Groves, and Richardson (FGR) conclude that “dumbbell portfolio strategies are not as efficient as indicated by previous analyses.” Among the previous studies to which they refer is one by Watson, who concluded that “portfolios split between a spaced group of short maturity bonds and a longer investment security” (barbell portfolios) are most efficient. Similar results are reported by Wolf and by Bradley and Crane.

Ceteris paribus, investors prefer to purchase municipal bonds selling close to their par value. That is, investors are willing to purchase at the lowest yield a municipal bond alike in all respects to other municipal bonds, but with a coupon that permits it to be sold at or near its par value. Conversely, investors are willing to purchase municipal bonds with coupons that cause them to be sold at prices either greatly above or greatly below par only at penalty or premium yields relative to similar par bonds.

During the past few years several money demand functions have been estimated for the United States. Although these functions may differ on the precise specification of the independent variables, most agree on their crude identity. Thus almost all functions include an income or wealth constraint and an interest rate price. Such functions have been applied exhaustively to data for various periods in United States history, both for the long run and for the short run. With few notable exceptions, the results differ more in degree than in substance. The quantity of money demanded is estimated to be a positive function of the constraint and a negative function of price. The studies have, however, overlooked an important body of possible collaborative evidence–that for other industrial countries. It may be reasonable to assume that the same basic forces underlie the demand for money in all industrial countries, it is of interest to contrast money demand functions for these countries with those obtained for the United States. This paper estimates demand functions for leading industrial countries and evaluates the results. No new theory is developed; rather, existing models are fitted to additional data to test their applicability to other countries.