Introduction The recent crisis is a source of new and complex challenges, but it does not only represent an unprecedented

moment of economic and financial turmoil. New evidences, findings and exceptional policy actions are an opportunity to set new standards and improve the regulation and decision frameworks in the financial market. The changes in the economic scene of the past decade, marked by strong diversification, built up interconnections among actors only individually insured, unaware of the rising systemic risk and of the spread of shock transmission.1 The causes of the global credit crisis, early source of the actual situation, can be summed up saying that the dynamic financial innovation didnt meet an adequate response from the regulation system, flawed and loose in its policies and lacking of transparency.2

o Interventions sorted by time Once identified the economic theory underlying this failure, it is not necessary to condemn the overall financial innovations which led to the crisis. Otherwise, it is time to find solutions for the structure of a renewed regulation system in order to safely take advantage of these innovations.1 Institutions and policy actions regulate the risk in the financial market to enforce the compliance needed to ensure safety. They can be distinguished between ex ante - i.e. before an event with negative repercussions occurs in order to prevent it - and ex post - i.e. actions taken after an event to solve it and develop improvement for future occurrences. The range of possible interventions is thus divided into two branches, on the base of a time line distinction.3

D. Acemoglu. The crisis of 2008: structural lessons for and from economics. CEPR, Policy Insight N28, January 2009 2 E. Avgouleas. The Global Credit Crisis, Behavioral Finance, and Financial Regulation: In Search of a New Orthodoxy. (Section C) 9 Journal of Corporate Law Studies, February 2009 3 Y. Hiriart, D. Martimort, J. Pouyet. The public management of risk: Separating ex ante and ex post monitors. Paris-Jourdan Sciences Economiques, Laboratoire DEconomie Applique INRA, Working Paper N 2009 - 20

First, with regard to the ex ante improvement path, it is necessary to critically review and analyze the limits of the crises forecasting models. These tools, the early warning system (EWS) models, are imperfect by definition due to their multidimensional principles, the several

methodology approaches and the different objectives linked to specific users. They are supplements for prediction in specific environments rather than Omni-comprehensive instruments.4 The subject has evolved on an always more macro prudential path since 2006, focusing on the introduction of risk factors able to mark systemic risk. The development of the core indicators has tried to adapt to the dynamic conditions of the financial market proving the basic pattern of the crises. Despite this achievement, the models still lack in the explanation of crises speed, impact and amplification, which require further work and analysis.5 That being so, crises prediction cannot be considered a safe firewall for financial markets and economies in the short run.

Secondly, the ex post intervention is represented by the implementation of a completely regulatory overhaul. While comprehensive reforms takes many years, there is a need to set a new framework for future policy actions in the short run. This can be achieved through a portfolio of guidelines and instruments to increase transparency,

predictability of intervention. The past experience has shown how market stability is linked to the time inconsistency problem which can be solved only through the supremacy of rules over discretion.6

E. Davis, D. Karim. Could early warning systems have helped to predict the sub-prime crisis? Brunel University and NIESR, London, 2008 5 D. Gramlich, G. Miller, M. Oet, S. Ong. Early warning systems for systemic banking risk: critical review and modeling implications. Banks and Bank Systems, Volume 5, Issue 2, 2010 6 J. Taylor. Toward a New Framework for Exceptional Access. Presentation at the Policy Workshop on The Future Role of Central Banking: Urgent and Precedent-Setting Next Steps, 22 July 2008

These concepts, claimed by John B. Taylor, compose the underlying ground of my work and outline an alternative path to come out from the present crisis and prevent the future ones. His suggestion is to implement an exceptional access framework (EAF) to support bailout decision of specific failing or stressed financial institutions. This proposal is modeled on the EAF of the International Monetary Fund (IMF). These predictable loan guidelines, after being reformed in 2003, brought to an end crises in emerging market economies lasting since 1994.7 Nowadays a turn in a quantitative direction, strengthening rules to avoid the lack of predictability and to restore equilibrium through welldefined principles and methods, may be replicable for an access framework to government support for financial institutions.8

o Political-economic environment and model Timeliness, efficiency and usefulness are core features of both the ex-ante and ex-post fields. While in the former these aspects are the pure objectives of the methodology, their role in the latter field is more critical as they mix with other political and distorting elements. The main assumption is that ex-post tools during an economic crisis such

governments bailout decisions can be improved through transparency to reach higher levels of timeliness, efficiency and usefulness.

The objective of this work is to construct a tool which match these characteristics, also in order to express a judgment on the quality of past decisions taken since the beginning of the crisis.

J. Taylor. Lessons of the Financial Crisis for the Design of the New International Financial Architecture. Written Version of Keynote Address. Conference on the 2002 Uruguayan Financial Crisis and its Aftermath, Montevideo, 29 May 2007 8 J. Taylor. The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong. Rock Center Working Paper No. 30, January 2009 3

For this reasons I introduce some assumption on the political-economic environment and a simple model to outline the main hypotheses on which I base my analysis.

First, I analyze the role and actions of a national government in the ongoing crisis. The options I am interested in can be divided once again by the time horizon. Medium run: The debate on ex post regulation and its transformations to fit the new financial and economic situation involves different levels of discussions, especially supranational. Its effects will be perceived after the end of the crisis and will work as an improved firewall to prevent and solve future crises. Short run: There are several cases in which the government has to decide on the bailout of financial institutions facing the threat of bankruptcy. These decisions can be fundamental in the determination of the evolution path of the crisis in one country and in the overall economic system. The correct choice can help to ease the crisis, the wrong one can deepen it.

I am interested in the short run policy actions and in a methodology to obtain the best bailout pronouncement on a bank or financial institution issue. The aim is to give a defined shape to the scenario under strict rules and guidelines despite the reduced time slot available. The stress is on an accurate tool able to cross the wall of the small window of time in which quantitative analysis can be performed due to time constraint. The idea is to implement an index to quickly process the information and avoid the negative repercussions of decisions based only on qualitative analysis.

The government is composed by incumbent politicians. They are opportunistic agents who do not maximize social welfare when taking decision because affected by the objective to be reelected: they are office seeking. In this model as usual, they want to please the electorate to be reelected. 9 The government is in charge for the bailout decision of the financial institutions. This position is critical, I assume that voters ask for solutions that positively affect only their present economic condition and thus far from being economically efficient in a longer horizon. This request takes place when there is a lack of information on the real financial position of the financial institution under exam i.e. quantitative analyses has no weight in the decision because incomplete.

Therefore it is possible to specify and distinguish between two different type of analyses able to influence the bailout decision. A qualitative analysis is composed by financial/economic judgments and can be biased by elements and powers of the political scene. I assume it represents a decision taken under discretion, without following the established rules for policy action. This tendency to act under unusual and exigent circumstances aliments uncertainty and adds market instability. Beyond this problem, it also allows political intermissions in the decision process over the issue. For these reasons, I consider this part the section of analysis which can lead to inefficiency. Because of the complexity with which economic and political interests collide in a qualitative analysis it is not possible to split it into two definite parts. I consider it as a whole. A quantitative analysis aims at reaching an economically efficient decision as it is built over strict rules, criteria and guidelines and
9

T. Persson, G. Tabellini. Political Economics: Explanatory Economic Policy. (Chapter 2) The MIT Press Cambridge, Massachusetts, London, England, 2000 5

it is data-driven: the balance sheet, current account and cash flow data are taken as crisis factor and whether above or under certain levels become indicators to enlighten the scenario and guide through the appropriate bailout decision. The quantitative analysis may results in a very long process to establish the effective health of a financial institution, while the decision has to be taken in the short run and so the timeliness is fundamental. As a consequence, the quantitative analysis will affect the decision only for the part that is processed before the bailout decision is taken. Following this reasoning the share of B in the decision is multiplied by a parameter (0,1), where with =1 all the quantitative analysis has been processed, with =o, none.

From the description of the two types of analysis above, I assume the quantitative one is the one leading to economic Efficiency and the qualitative one bring to the opposite state. I distinguish between a qualitative, A [-1,1], and a quantitative, B [-1,1], analysis of the scenario in which the financial institution is involved, with the positive value in favor of bailout and the negative against. I assume that the two analysis have different results and so whether A=1, B=-1 and the opposite. The final bailout decision, ={Yes, No}, will be the sum of the two type of analysis, where (0,1) is the share of A considered in the decision and (0,1) the share of B, with +=1. The outcome of is then determined by the sum of the value of the shares of A and B and the final outcome Yes is associated with a positive value and No with a negative one.

Then the bailout decision is = A+B

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= A+(1-)B.

Given the value of A as fixed, as its effect cannot be diminished by any multiplier, it is possible to influence the outcome increasing the weight of B in the equation and thus processing the quantitative analyses in a way that can furnish accurate results (Usefulness) in a Timeliness perspective. To achieve this result it is necessary to build a tool able to increase , which will be closer to 1 and give a bigger weight in the bailout equation to the variable B.

In this state, whether we reach =1 and consequently B=-1 or 1, the outcome still depends on the value of the share the two analysis have in the equation. So, an larger than would make the effect of our instrument ineffective, as the qualitative analysis would remain

preponderant in the decision. Assume now that there is also an indirect effect of the increase of . When the information of the quantitative analyses approaches the completed status, ->1, the probability that the share of the quantitative analyses is bigger than the qualitative one, approaches one, Pr[ > | ->1 ]->1. This is the consequence of the fact that with a relatively more complete quantitative information, the final decision will be based more on a robust quantitative base. The citizens will rely on it and push for it, as it reduce their disinformation. With more information they are brought to prefer an economically efficient solution rather than a qualitative one, they know is predominantly inefficient and political driven. With >, the sign of is determined only by the sign of B, the quantitative, and efficient, analysis. Proposition: If and only if ->1 and thus >, then
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>, is increasing and

sign = sign B, with Probability=1

Under the previous assumptions and in the political economic environment I have drawn it is then worthy to implement quantitative instruments to help governments in bailout decisions, reducing the weight of destabilizing and inefficient positions.

In section 4 the core of the analysis is developed. I merge elements of the EWS models and of The EAF of the IMF to build an instrument to ease governments bailout decision. This index will comprehend element of the EWS models which are focused in the micro prudential field to forecast capitalization crises. Their risk factors labeled as risk indicators as well, will be joint to the strict features, including rules and guidelines, of the IMF reform of the AEF. The tool will be used to investigate a series of case studies on banking and financial institutions which have faced a bailout decision in the current crisis.

Figura 1 - Theoretical process to build the tools to improve governments bailout decisions

In section 5 I conclude and discuss the results and whether the instruments Ive built is able to show how bailout decisions have been taken. I will try to answer these questions: The past decisions were mainly qualitative driven: the degree of discretion was very high? Institutions which were saved, shouldnt have been bailout and vice versa? In particular the answer to this second question will be based on the ability of the saved institution to keep producing loss in the short/medium period after the bailout

Questi factor dati per buoni e non con regression con altee banche non fallite Che per potrebbe essere double check per robustezza