We study bank policies to limit lending to companies engaged in mountaintop removal (MTR) coal mining, a form of coal extraction that has raised many environmental concerns. Using the staggered introduction of these policies, we document that these policies did not lead to meaningful changes in average bank lending or MTR mining. However, larger banks, banks that are under media pressure, and banks operating in the affected states are more likely to reduce MTR loans. Our results are consistent with the hypothesis that banks announced these policies under pressure and to improve their green credentials.

I discuss changes to bank supervision and regulation since the financial crisis. Microprudential supervision promotes the safety and soundness of individual institutions, while macroprudential supervision focuses on emerging risks to financial system stability. I highlight tools for implementing this macroprudential approach to promoting financial stability, and discuss the interactions and proper relationship between monetary policy and financial stability. While macroprudential tools should be the first line of defense against emerging financial imbalances, in cases where those tools proved to be inadequate to limit risks to financial stability, monetary policy should be considered as a possible defense.

This paper introduces two methods of hiding loan losses and analyzes how they affect a bank's loan interest income, payments on deposits, liquidity and moral hazard. The analysis reveals that a hiding method represents a Ponzi scheme. Contrary to classic theory, e.g. Diamond (1984), moral hazard may arise even though a bank's loan portfolio is diversified. Alternative instruments to eliminate hiding are investigated. Under specific circumstances, a Ponzi scheme may provide a socially optimal method to create liquidity and prevent a failure of a solvent but illiquid bank.

Basel II attempts to eliminate incentives for regulatory capital arbitrage and align capital regulation with best practices in credit risk management. Despite the imposition of very heavy compliance costs, it is unlikely to succeed in achieving either goal. This paper describes an alternative approach, based on mandatory issues of subordinated debt, which makes use of market discipline to achieve these goals at much lower cost.

We develop a model in which individual and institutional reputation concerns conflict with one another to study why investment bank reputation concerns may have diminished in recent years. Unproven but talented bankers have incentive to signal their ability through actions that may or may not best serve their clients. In the spirit of Kreps (1990), we treat the bank as a hierarchical firm whose only asset is its institutional reputation for curbing behavior that is suboptimal for the client. The conflict between individual and institutional reputation concerns is more likely to resolve in favor of institutional reputation when firms recruit only the most talented people, and less so when unique ability is especially valuable. We discuss how technological change has contributed to a “star” culture that is unfavorable toward preservation of institutional reputation.

We develop a model in which it is predicted that more resources will be devoted to safety in a workers' compensation system with experience-rated premiums than in one with flat-rated premiums. We test this model by observing the effect on fatality rates of the move from flat rating to experience rating in the forestry and construction industries of Ontario, Canada. The evidence provides strong confirmation of the theory.

We construct a simple measure of the aggregate illiquidity of hedge fund portfolios, based on the cross-sectional average first-order autocorrelation coefficient of hedge fund returns, and show that it has strong and robust in- and out-of-sample forecasting power for 72 portfolios of international equities, U.S. corporate bonds, and currencies over the 1994 to 2013 period. The forecasting ability of hedge fund illiquidity for asset returns is in most cases greater than, and provides independent information relative to, well-known predictive variables. We rationalize these findings using a simple equilibrium model, in which hedge funds provide liquidity in asset markets.

This paper proposes a theory of redemption runs based on strategic information acquisition by fund managers. We argue that liquidity lines provided by third parties can be a source of financial fragility, as they incentivize fund managers to acquire private information about the value of their assets. This strategic information acquisition can lead to inefficient market liquidity dry-ups caused by self-fulfilling fears of adverse selection. By lowering asset prices, information acquisition also reduces the value of funds’ assets-under-management and may spur inefficient redemption runs by investors. Two different regimes can arise: one in which funds’ information acquisition incentives are unaffected by the volume of redemptions, and another where market and funding liquidity risk mutually reinforce each other.

We explore the optimal financial contract for a large investor with potential control over a firm's investment decisions. An optimal menu of claims resembles a U.S. version of lender liability doctrine—equitable subordination. This doctrine permits the court to subordinate a controlling investor's claim in bankruptcy, but only under well-specified conditions. It allows a firm to strike an efficient balance between: (i) inducing the large investor to monitor, and (ii) limiting the influence costs that arise when claimants can challenge existing contracts. We provide a partial rationale for a financial system in which powerful creditors do not hold blended debt and equity claims. Journal of Economic Literature Classification Numbers: G20, G33, K22.

Banks are modeled as Bryant/Diamond-Dybvig "insurers" against the risk of early consumption. Consumption claims must be verified by clearing and settlement. A clearinghouse does this efficiently as long as banks are sufficiently liquid. If liquidity requirements cannot be enforced against all banks then the threat of panics is necessary to induce banks to hold sufficient liquidity. If the clearinghouse can issue emergency currency, then banks can coexist with less liquid institutions. However, if banks′ return to holding reserves is low during "normal times," then there must be times when the return to liquidity is abnormally high. We associate these episodes with the panics of the National Banking Era. Journal of Economic Literature Classification Numbers: 042, 311, 314.