Date of Award

Spring 1-1-2013

Document Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Political Science

First Advisor

Moonhawk Kim

Second Advisor

Andy Baker

Third Advisor

Joseph Jupille

Fourth Advisor

David Bearce

Fifth Advisor

Robert McNown

Abstract

My dissertation seeks to explain why policymakers sometimes issue guarantees for bank liabilities during a banking crisis. Though such guarantees have the potential to contain the crisis by averting bank runs, they create massive contingent obligations for the government and are thus a risky approach to crisis containment. Although such guarantees are not new, their use has become increasingly common. I emphasize the effects of globalization in shaping the decision of policymakers in adopting this risky crisis containment strategy. One important consequence of the ease and speed with which money now moves across borders is that it raises the stakes in dealing with banking crises; the cross-border flight of capital threatens to intensify deteriorating conditions in the domestic banking sector and potentially trigger a wider macroeconomic crisis. Uncertainty about how much money might flee and what the ultimate economic effect might be makes policymakers more inclined to take on the considerable risks associated with bank guarantees. Moreover, the alternative strategy of simply closing the borders to capital outflows (i.e. the imposition of capital controls) in states that have embraced financial openness is likely to be a politically unattractive - if not unfeasible - alternative. To evaluate the argument, I examine the relationship between de jure capital openness (which approximates a state's vulnerability to capital flight) and the use of bank guarantees. Using multinomal logit analysis, I also evaluate the effect of openness on the likelihood that governments will adopt capital controls in response to a crisis, given the alternative of issuing bank guarantees. Finally, I test an observable implication that flows from the argument, which is that the use of guarantees by one state creates competitive distortions in international banking markets that push other states to adopt guarantees as well in order to prevent capital from fleeing to government-backed investments in competitor states. The results of the analysis contained herein point to a strong relationship between the use of bank guarantees and the threat of capital flight during a crisis.

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