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Interbank Networks in the Shadows of the Federal Reserve Act

contagion and resiliencefinancial networksinterventions and regulations in networksR&Rstrategic network formationWorking papers
with Haelim Anderson, Guillermo Ordoñez
Revise and resubmit, Review of Economic Studies
Year: 2022

Central banks provide public liquidity (through lending facilities and promises of bailouts) with the intent to stabilize the financial system. Even though this provision is restricted to member (regulated) banks, an interbank system can provide indirect access to nonmember (shadow) banks. We construct a model to understand how a banking network may change in the presence of central bank interventions and how those changes affect financial fragility. We provide evidence showing that the introduction of the Fed’s liquidity provision in 1913 increased systemic risk through three channels; it reduced aggregate liquidity, created a new source of financial contagion, and crowded out private insurance for smoothing cross-regional liquidity shocks (manifested through the geographic concentration of networks).

Best paper on financial institutions, Western Finance Association, 2020, sponsored by Elsevier

Civil Liberties and Social Structure

Governments use coercion to aggregate distributed information relevant to governmental objectives –from the prosecution of regime-stability threats to terrorism or epidemics–. A cohesive social structure facilitates this task, as reliable information will often come from friends and acquaintances. A cohesive citizenry can more easily exercise collective action to resist such coercion, however. We present an equilibrium theory where this tension mediates the joint determination of social structure and civil liberties. We show that segregation and unequal treatment sustain each other as coordination failures: citizens choose to segregate along the lines of an arbitrary trait only when the government exercises unequal treatment as a function of the trait, and the government engages in unequal treatment only when citizens choose to segregate based on the trait. We characterize when unequal treatment against a minority or a majority can be sustained, and how equilibrium social cohesiveness and civil liberties respond to the arrival of widespread surveillance technologies, shocks to collective perceptions about the likelihood of threats or the importance of privacy, or to community norms such as codes of silence.

Insider Networks

How do insiders respond to regulatory oversight? History suggests that they form sophisticated networks to share information and circumvent regulation. We develop a theory of the formation and regulation of information transmission networks. We show that agents with sufficiently complex networks bypass any given regulatory environment. In response, regulators employ broad regulatory boundaries to combat gaming, giving rise to regulatory ambiguity. Tighter regulation induces agents to migrate transmission activity from existing social networks to a core-periphery insider network. A small group of agents endogenously arise as intermediaries for the bulk of information. We provide centrality measures that identify intermediaries.