Be careful what you wish for: the stock market reactions to bailing out large financial institutions: Evidence from the USA

Abstract

Purpose

The purpose of this paper is to examine the implicit subsidies received, in the form of stock market returns, from the perception that large banking organizations are too big to fail, and implications for financial regulation.

Design/methodology/approach

The empirical analysis focuses on the responses of stock prices of various size groups of banking organizations to announcement of government capital injections to banks (troubled assets relief program) during the 2008 financial crisis, and summarizes responses of regulatory authorities to the crisis.

Findings

The paper finds positive and statistically significant stock return reactions both for a portfolio of the large banking organizations that are part of the initial capital injection plan and a portfolio of the large banking organizations that are not part of the initial capital injection plan, implying a too‐big‐to‐fail (TBTF) effect, especially for the latter group of institutions.

Research limitations/implications

The paper focuses on a short time frame of stock price reactions to specific events, for the largest US banks. Further examination of longer‐term stock price effects on US as well as foreign banks may be of interest.

Practical implications

The results have implications for the manner and scope of financial regulatory actions and changes in regulators' approaches to systemic risk and individual bank regulation.

Originality/value

The paper examines TBTF bank subsidy effects in response to a rapidly unfolding financial crisis. These have implications for longer term responses, particularly in the regulatory sphere.

Citation

Brewer, E. and Klingenhagen, A.M. (2010), "Be careful what you wish for: the stock market reactions to bailing out large financial institutions: Evidence from the USA", Journal of Financial Regulation and Compliance, Vol. 18 No. 1, pp. 56-69. https://doi.org/10.1108/13581981011019633