The Bankers' New Clothes by Anat Admati

Author:Anat Admati
Language: eng
Format: epub
Publisher: Princeton University Press
Published: 2023-10-06T00:00:00+00:00

32. In the 1990s, the effect of government guarantees on borrowing costs was at the center of complaints against the Landesbanken, public banks in Germany that enjoyed such guarantees. For these banks, rating agencies actually published separate credit ratings with and without the guarantees. Typical ratings would be AAA, the best possible, with the government guarantees, and CCC, many grades lower—in fact “junk bond” status—without the guarantees. Because this effect gave the Landesbanken a substantial advantage in borrowing, the European Commission ruled that the (explicit) guarantees represented a form of state aid that distorted competition and was therefore incompatible with what is now the Treaty on the Functioning of the European Union (Art. 107). Germany initially contested the Commission’s ruling but eventually gave in. Avoiding a lengthy trial before the European Court of Justice, in 2001 the Commission and the German government agreed that, from 2005 on, no further guarantees would be given. See European Commission, “Germany Agrees on the Implementation of the Understanding with the Commission on State Guarantees for Landesbanken and Savings Banks,” press release, February 28, 2002, http://europa.eu/rapid/pressReleasesAction.do?reference=IP/02/343&format=HTML&aged=1&language=EN&guiLanguage=en, accessed September 28, 2012. In the United States, a similar effect could be observed with Freddie Mac and Fannie Mae, two of the so-called government-sponsored enterprises. For years these banks enjoyed high credit ratings, between A and AAA, even though they were very risky and had little equity. The rating agencies were confident that, if necessary, the U.S. government would bail them out, and this is exactly what happened in 2008; see Acharya et al. (2011a) and Chapter 17 of FCIC (2011). The importance of implicit guarantees for the funding costs of banks, particularly those that are considered too big to fail, is discussed in Chapter 9.

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