“Is this a Lehman moment?”
In the days after the U.K. Brexit referendum, that was the leading question many people were asking. It is the right question. Unfortunately, despite years of regulatory reform in the aftermath of the financial crisis, the answer is: we don’t know. That is why policymakers are especially worried about heightened financial volatility in the aftermath of U.K. voters’ decision to leave the European Union....
Read MoreCapital—the excess of assets over liabilities—determines solvency, so policymakers are used to thinking of it as a tool for keeping banks and the banking system safe. House Financial Services Chair Hensarling’s proposal to allow banks to opt for a simple capital standard that would substitute for other regulatory oversight is just the most recent example.
But bank capital also is a critical factor in the transmission of monetary policy. When central banks ease, their actions are intended to encourage banks to lend and firms to borrow. And, to put it simply: healthy banks lend to healthy firms, while weak banks lend to weak firms (if at all)....
Read MoreProfessor Mervyn King, our friend, NYU Stern colleague and the former Governor of the Bank of England, has written a wonderfully insightful and thought-provoking new book, The End of Alchemy. His goal is not just to explain the sources of the 2007-09 crisis, but to provide a template for financial reform that would reduce the frequency and severity of future crises. In the end, Professor King proposes a radical structural change intended to make banking safe while preserving the intermediation function that is critical to modern economies.
The alchemy to which Professor King refers in his book’s title is banks’ traditional function of transforming high-risk, illiquid and long-maturity assets into low-risk, liquid and short-term liabilities. But, in the presence of limited liability for the banks’ owners and the government safety net (in the form of deposit insurance and the lender of last resort that remove both solvency and liquidity risk for the depositors), banks’ incentive is to transform too much. Holding assets that are overly risky, insufficiently liquid and too long-term makes banks fragile and run-prone, providing fodder for systemic crises....
Read MoreThat overly optimistic credit ratings contributed significantly to the Great Financial Crisis is now widely acknowledged (see, for example, here and here). One welcome result has been a wave of research that highlights the influence of biased credit ratings on the real economy and identifies potential remedies. In this note, we examine stylized facts about ratings performance that emerge from this new work; discuss the economic impact of ratings; and, finally, consider remedies for conflicts of interest that contribute to the problem...
Read MoreReserve Bank of India Governor Raghuram Rajan’s recent plea for increased coordination is merely the latest protest by emerging-market economy (EME) policymakers about the spillovers from advanced-economy (AE) monetary policy. Such complaints have been common since AE central banks first implemented unconventional policies in 2008. The most famous was Brazilian Finance Minister Guido Mantega’s September 2010 remark that “We’re in the midst of an international currency war.”
The targets of these comments—policymakers in Europe, Japan and the United States—responded that the world would be better off if their economies grew. A deeper recession in the advanced world was surely in no one’s interest. Extraordinary monetary policy easing was therefore justified by both domestic and global concerns. U.S. and European policymakers further defended their actions by saying that their mandate was to promote price stability and sustainable growth domestically, which required taking account of the external impact of their policies only insofar as they then fed back onto their own economies. That is, while spillovers per se were not their responsibility, spillbacks were.
Debates over the potential benefits from international policy coordination have a long history...
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In early 2015, we expressed skepticism about the prospects for peer-to-peer (P2P) lending. Like other efforts to slash financial transactions costs (think “block chain”), P2P was all the rage. The notion was that the lenders and borrowers could cut out the middle man, “disrupting” traditional finance.
For that to work, for P2P investors to get an attractive risk-adjusted return, it would have to embody a technology that can screen and monitor borrowers at a lower cost than do existing intermediaries in the long-established sector of consumer credit. That seemed especially doubtful in a competitive industry like credit card lending, which is what P2P lending often turns out to be...
The time has come to start weighing in on presidential candidate Donald Trump’s statements on economic policy. Today, we examine his comments about U.S. government debt. After saying that he is the “king of debt” and that he “loves debt,” Mr. Trump recently went on suggest that if interest rates were to rise, he would seek to “make a deal” on U.S. Treasury debt. In his words, “I could see long-term renegotiations where we borrow long term at very low rates.” He also called this action: “refinance debt with longer term.”
Mr. Trump appears to assume that his sensibilities as real estate mogul and dealmaker can be directly applied to government debt management policy. They cannot. Treasury securities bear absolutely no resemblance to the debt issued by Trump Entertainment Resorts, which went bankrupt in 1991, 2004, 2009, and 2014...
Read MoreTo borrow a phrase, a crisis as deep as the 2007-2008 collapse of U.S. housing finance is a terrible thing to waste. Yet, nearly eight years after investors shunned their debt, Fannie Mae and Freddie Mac remain in federal conservatorship. And there is no end in sight to the government’s dominant role in housing finance: securitizations by the GSEs and federal agencies still accounted for nearly 70% of originations in 2015 (with qualifying loan-to-value ratios as high as 97%). Despite this extensive government intervention in mortgage finance, the U.S. home ownership rate fell to 63.6% last year, its lowest level since 1966.
To say that U.S. housing finance is both inefficient and risky seems a dramatic understatement...
Read MoreA highly leveraged financial system is one prone to collapse. This notion underlies modern financial regulation: the control of systemic risk requires controlling leverage. And, it is what drives proposals for high capital requirements and to tax leverage. But, as is always the case with regulation, the devil is in the details. For one thing, we need a way to measure leverage. This turns out to be a surprisingly difficult task. Second, while risk varies positively with leverage, risk-taking can increase without increasing leverage, so we need to think about all major forms of risk-taking that can threaten financial stability...
Read MoreDespite mixed evidence, concerns about a decline of bond market liquidity persist. The typical worry is that a sudden decline in bond demand will cause prices to plunge and have serious knock-on effects.
Naturally, the issue merits attention: episodes in which market liquidity disappears rapidly can be disruptive (witness the flash crashes and flash rallies in various equity and bond markets in recent years). However, these incidents tend to be fleeting. Instead, from the perspective of financial stability, funding liquidity is the greater source of vulnerability...