BANK RUNS, IMMEDIACY, AND BANKRUPTCY LAW: DEPOSIT CONTRACTS AS A PROBLEM IN HOSTAGE TAKING (DEPOSIT INSURANCE)

This dissertation argues that the distinguishing features of banking firms are their offer of immediacy in redeeming deposits and the synergies that exist between deposit-taking and investing in certain types of illiquid assets. In a deregulated world, such banking firms would present unique problems in applying bankruptcy law. Banks would seek to avoid the costs of runs by invoking the principles of bankruptcy law. But the presence of illiquid assets means bankruptcy would be time consuming under current laws, which is inconsistent with the offer of immediacy. As a result, both banks and depositors would seek to include alternative bankruptcy rules in deposit contracts.; Such contracting problems are analogous to those studied in the transaction cost economics literature. Banks seek the higher returns from illiquid assets, yet face a long-term contracting problem in ensuring continuous financing. Banks therefore would ask creditors to protect its investment with a hostage. The dissertation argues that a third-party is needed to offer this protection, and it further argues that due to contracting problems that this third-party would logically offer deposit insurance as the hostage. The deposit insurer, in turn, would seek protection from the moral hazard problem. Interesting contracting problems result.; The dissertation also analyzes an alternative solution to the problems created by deposit contracts. Transaction cost economics suggests that the contracting costs of vertically integrating may be too steep for some transactions. By the same logic, banks may find it easier to stop holding the illiquid assets that are the source of the problem with deposit contracts. Banks could unbundle the liquidity transformation they perform, keeping the maturity transformation while shifting to other firms the role of playing market maker for illiquid assets.; Banks that invest in illiquid assets rule out mutual fund structures, because of the difficulty of having fund shares serve as the medium of exchange when market valuation of the shares is costly. But without illiquid assets, the result may be a banking system similar in some ways to that described in the new monetary economics literature.