Essays on the political economy of financial crises : causes, containment and resolution

What role does politics play in financial crises and how does this affect economic outcomes? This thesis employs a political economy framework to examine the effect politics has on the causes, containment, and resolution of financial crises. The first paper examines the development of Irish financial regulation and supervision in the context of the politics of financial services policy. It argues that domestic politics prior to the crisis in Ireland played a significant contributing role in fostering a permissive banking environment which allowed the build up of financial imbalances. The second paper, with Christopher Gandrud, aims to understand why policymakers may end up choosing sub-optimal financial crisis containment strategies when taking decisions under uncertainty. We develop a signalling model of financial crisis management to enhance our understanding of the interactions between bureaucrats and decision-makers and to show how asymmetries of information can have significant implications for policy choice. The third paper, with Alessio Terzi, uses cross-country econometric evidence to examine the impact that political and party systems have on the fiscal cost of financial sector intervention. The results of our empirical analysis suggest that there is a systematic relationship between political economy factors and the fiscal cost of financial sector intervention in banking crises. We find that governments in presidential systems are associated with lower fiscal costs when managing banking crises. Looking further at crisis containment strategies, we show that these governments are are less likely to employ costly bank guarantees and bank recapitalisations which expose the state to significant contingent and direct fiscal liabilities, and are more likely to impose losses on depositors. The fourth paper analyses reform of the framework for crises management in the EU from a political economy perspective, following the 2007 financial and subsequent sovereign debt crisis. It explains how the limits of coordination and unprecedented public support led to the proposal for the establishment of a harmonised framework for bank resolution across the EU. However, the distributional consequences of financial sector support and the establishment of the Single Supervisory Mechanism led to deeper integration for euro area Member States and agreement on the Single Resolution Mechanism. It analyses in detail the negotiations on the financing structure for future resolution, decision-making procedures and crisis management tools and demonstrates how the power of certain Member States and distributive conflict with regard to legacy assets shaped the new architecture. It also highlights the important role the European Parliament played in the negotiations. This thesis makes a number of substantive contributions to political economy. The new theoretical and empirical findings will help foster a better understanding as to how governments may react to future financial crises and show what factors lead to and shape reform. It also has a number of policy implications. It stresses the need for a robust regulatory and supervisory architecture which creates the appropriate incentives for bureaucrats to provide timely and accurate information to decision-makers. It also highlights the need for a more intrusive approach to supervision.