Bank Bailout Menus

Bailing out banks requires overcoming debt overhang as well as dealing with adverseselection with respect to the quality of banks' balance sheets, in terms of heterogeneity inboth the likelihood and extent of their potential shortfalls, of future asset values vis-a-viscontractual debt obligations. We examine bailouts that eliminate debt overhang, whileattempting to minimize subsidies to banks' equityholders. When banks do not dier withrespect to the extent of debt overhang, it can be fully overcome with the minimal amountof subsidies, providing each bank's equity holders no more than their pre-bailout values,with a partial new equity injection, or an asset buyout. When levels of debt overhang co-vary with underlying probabilities of default, we characterize the conditions for attaininga similar minimal subsidy outcome, with a Menu of either equity injection or asset buyoutplans, satisfying suitable self-selection constraints among bank types.[...]