A few items from the ‘sphere that you might find interesting.
Correlation seeking. Alex Tabarrok notes a paper by Richard Squire that expands on the familiar idea that firms with more debt may be inclined to take more risk. Contingent debt, Squire argues, can induce management to seek assets whose negative outcomes occur in the firm’s bankruptcy state. Squire writes:
Conduct that is consistent with correlation-seeking played a central role in the 2008 financial crisis, causing the deep losses suffered by the three firms to receive the biggest bailouts: AIG, Fannie Mae, and Freddie Mac. Yet current and proposed legal rules for derivatives and other contingent debt contracts ignore matters of correlation, increasing the risk of another financial crash in the future.
Fed’s balance sheet. David Merkel has details of some of the AIG assets held by the Federal Reserve, though I don’t share his assumption that the Fed didn’t know they were getting junk.