The disposition of failed Japanese bank assets: lessons from the U.S. savings and loan crisis

This paper reviews the Japanese experience with "put guarantees" recently offered in the sale of several failed banks. These guarantees, meant to address information asymmetry problems, are shown to create moral hazard problems of their own. In particular, the guarantees make acquiring banks reluctant to accept first-best renegotiations with problem borrowers. These issues also arose in the U.S. savings and loan crisis. Regulators in that crisis turned to an alternative guarantee mechanism known as "loss-sharing arrangements" with apparently positive results. I introduce a formal debt model to examine the conditions determining the relative merits of these guarantees. The results show that both forms of guarantees reduce expected regulator revenues and that the impact of economic downturns on the relative desirability of the two guarantees is ambiguous.