Journal of Economic Dynamics and Control

Peter Klimek, Sebastian Poledna, J. Doyne Farmer, Stefan Thurner doi:10.1016/j.jedc.2014.08.020

Since the beginning of the 2008 financial crisis almost half a trillion euros have been spent to financially assist EU member states in taxpayer-funded bail-outs. These crisis resolutions are often accompanied by austerity programs causing political and social friction on both domestic and international levels. The question of how to resolve failing financial institutions, and how this depends on economic preconditions, is therefore a pressing and controversial issue of vast political importance. In this work, the authors employ an agent-based model to study the economic and financial ramifications of three highly relevant crisis resolution mechanisms. To establish the validity of the model, they show that it reproduces a series of key stylized facts of the financial and real economy. The distressed institution can either be closed via a purchase & assumption transaction, it can be bailed-out using taxpayer money, or it may be bailed-in in a debt-to-equity conversion. They find that for an economy characterized by low unemployment and high productivity the optimal crisis resolution with respect to financial stability and economic productivity is to close the distressed institution. For economies in recession with high unemployment the bail-in tool provides the most efficient crisis resolution mechanism. Under no circumstances do taxpayer-funded bail-out schemes outperform bail-ins with private sector involvement.