The International Financial Crisis: Have the Rules of Finance Changed?

Contents......Page 10
Preface......Page 6
Acknowledgments......Page 8
I. Special Addresses......Page 14
The International Financial Crisis: Asset Price Exuberance and Macroprudential Regulation Charles L. Evans, Federal Reserve Bank of Chicago......Page 16
References......Page 24
1. The Initial Shocks......Page 28
2. The Policy Response......Page 31
3. Other Stabilizing Forces......Page 34
4. The Outlook for Recovery......Page 37
5. The Challenges Ahead......Page 39
References......Page 41
Getting the New Regulatory Framework Just Right: Six Questions for Policymakers José Viñals, International Monetary Fund......Page 44
1. Microprudential Regulatory Reforms......Page 45
2. Macroprudential Regulatory Reforms......Page 47
3. Getting Things Just Right......Page 49
References......Page 50
Longer Days, Fewer Weekends Kevin M. Warsh, Board of Governors of the Federal Reserve System......Page 52
1. The Task Ahead......Page 53
2. Preliminary, Provisional, Subject-to-Revision, Condition-Dependent Forecast......Page 55
2.1 First, when will the Fed’s extraordinary policy accommodation demand removal?......Page 56
2.2 Second, how might the policy response evolve?......Page 57
References......Page 59
1. Introduction......Page 60
2. An Ounce of Prevention......Page 62
2.1 Strengthening capital requirements......Page 63
2.2 More robust liquidity requirements......Page 64
3. Facilitating the Orderly Resolution of Banking Problems......Page 65
References......Page 67
II. What Broke? The Root Causes of the Crisis......Page 70
1. Introduction......Page 72
2.3 Housing demand built on itself to create a bubble in prices......Page 73
2.4 Shifting types of lending and the erosion of standards......Page 74
2.6 Securitization and the funding of the housing boom......Page 75
2.7 More securitization and more leverage — CDOs......Page 77
2.8 Structured investment vehicles and off-balance-sheet entities......Page 78
2.10 Credit insurance and the growth in credit default swaps......Page 79
2.11 The failure of company risk management practices......Page 80
3. What Is the Impact of Increasing Capital Requirements?......Page 81
4. Conclusions......Page 83
References......Page 84
1. Introduction......Page 86
2. Government Policy and the Origins of the Subprime Crisis......Page 89
2.1 Monetary policy and global imbalances......Page 93
2.2 Subsidization of mortgage risk......Page 94
2.3 Prudential regulatory failure......Page 95
2.3.1 Subprime ratings inflation and the regulatory reliance on ratings......Page 96
2.3.2 Too big to fail......Page 99
2.4 Corporate governance problems in large banks......Page 100
2.5 The size of the shock vs. the size of the crisis......Page 101
3. Conclusion......Page 102
References......Page 103
The Role of the Financial Sector in the Great Recession Michael Mussa, Peterson Institute for International Economics......Page 106
1. A Classic Boom/Bust Cycle......Page 107
2. The Financial Sector in the Global Recovery......Page 109
3. Availability of Adequate Financing......Page 115
4. The Long-Term Need for Deep Financial-Sector Reform......Page 118
5. The Inherent Instability of Banking......Page 119
6. Financial Repression, Financial Liberalization, and Moral Hazard......Page 121
7. The Investor of Last Resort......Page 123
8. The Fundamental Need for More Capital......Page 124
9. An Adequate Level of Bank Capital......Page 127
References......Page 129
What Broke? The Root Causes of the Crisis Edwin M. Truman, Peterson Institute for International Economics......Page 130
III. Containing a Systemic Crisis: Is There Really No Playbook?......Page 138
1. Introduction......Page 140
2.1 Policy mistakes behind the global financial crisis......Page 141
2.1.1 Flaws in financial regulation and supervision......Page 142
2.1.3 Weak global financial architecture......Page 143
2.2 Principles of crisis containment......Page 144
2.3 Macroeconomic and financial surveillance and macroprudential supervision......Page 146
3. Systemic Stability Regulation — Principles......Page 148
3.1 Clear objectives and mandates of a systemic stability regulator......Page 149
3.2 Sufficient regulatory resources to fulfill responsibilities......Page 150
3.3 Effective implementation by the systemic stability regulator......Page 151
3.4 Effective organization of a systemic stability regulator......Page 152
4.1 Global practices of central banks in financial stability......Page 154
4.2.1 U.S. stability reform plan......Page 157
4.2.3 European Union reforms......Page 160
4.3 Alternative models......Page 161
5. Conclusions......Page 164
References......Page 165
Dealing with the Crises in a Globalized World: Challenges and Solutions Vincent R. Reinhart, American Enterprise Institute......Page 168
1. A Romance of Geometry......Page 169
2. Six Degrees of Separation......Page 170
3. Crises and Learning from the Past......Page 171
References......Page 172
Systemic Risk: Is There a Playbook? Robert K. Steel, Wells Fargo & Co.......Page 174
IV. Dealing with the Crisis: The Role of the State......Page 180
1. Introduction......Page 182
2. Evolution in the Banking Safety Net......Page 184
3. The Time-Consistency Problem and the Banking Safety Net......Page 191
4.1.1 Introducing leverage limits......Page 199
4.1.3 Rethinking capital structure......Page 200
4.1.4 Reconsidering the industrial organization of banking......Page 202
4.2.1 A framework for the banking safety net......Page 203
4.2.2 Time-consistent liquidity insurance......Page 204
4.2.4 Time-consistent capital insurance......Page 205
References......Page 206
1. Introduction......Page 210
2. The Implementation of Monetary Policy in Major Central Banks Before the Crisis......Page 211
3. The Liquidity Component of the 2007–2009 Crisis......Page 213
4. An Overall Interpretation of the Actions of Central Banks During the Crisis......Page 216
5. An Assessment of the Effectiveness of Central Bank Actions......Page 221
6. Conclusion......Page 224
References......Page 225
1. Introduction......Page 226
2. The “Playbook” for Dealing with a Financial Crisis......Page 227
3. The Plays Run During This Financial Crisis......Page 228
3.2 Winnow insolvent banks......Page 230
3.4 Provide policy certainty......Page 231
3.5 Provide clarity on balance sheets......Page 233
4. Alternative Steps to Those Taken in Fall 2008......Page 234
5. Conclusion: What Could Have Been Done That Was Not Attempted?......Page 236
References......Page 237
Comments: Panel on the Role of the State Peter J. Wallison, American Enterprise Institute......Page 240
V. What to Do About Bubbles: Monetary Policy and Macroprudential Regulation......Page 248
1. Introduction......Page 250
2. Financial (In)Stability: Definition......Page 252
3.1 Role of measurement......Page 255
3.2 A taxonomy......Page 256
3.2.1 From balance sheet to market price indicators......Page 259
3.2.2 Early warning indicators......Page 262
3.2.3 Single-module measures: VARs......Page 264
3.2.4 Multiple-module measures: macro stress tests......Page 265
3.3 Overall assessment: from a financial stability to a macroeconomics perspective......Page 267
4. Financial (In)Stability: Policy......Page 269
4.1 Towards a macroprudential framework of regulation and supervision......Page 270
4.2 Towards a more preemptive monetary policy......Page 272
4.3 Towards a common research agenda......Page 275
References......Page 276
1. Introduction......Page 282
2.1 Assessment of capital adequacy......Page 284
2.2 Liquidity......Page 286
2.3 Remuneration......Page 287
2.4 Direct constraints......Page 288
2.5 Housing......Page 290
3.1 Direct constraints on bank activity......Page 291
3.2 Remuneration and risk taking......Page 293
3.3 Insurance......Page 294
3.4 Countercyclical regulation......Page 295
3.5 Housing......Page 296
4. Future Outcomes?......Page 297
References......Page 299
1. Economic Bubbles......Page 302
2. Revisiting Bubbles......Page 303
Reference......Page 306
What to Do About Bubbles: Monetary Policy and Macroprudential Regulation Marvin Goodfriend, Carnegie Mellon University......Page 308
Reference......Page 314
VI. Dealing with Crises in a Globalized World: Challenges and Solutions......Page 316
Dealing with Crises in a Globalized World: Challenges and Solutions Athanasios Orphanides, Central Bank of Cyprus......Page 318
References......Page 327
2. Diagnosis — This Is a Network Crisis......Page 328
2.1 Why did we not see this?......Page 329
3. Damage Control — How Do We Exit from a Massively Distorted System Under ZIRP?......Page 330
4. Loss Allocation — Essentially, Future Generations and Mother Earth Bear the Losses......Page 332
5. Changing the Incentives — Moral Hazard Is Directly Related to Leverage, so Controlling Overall Leverage Will Keep the System Stable......Page 334
6. Concluding Thoughts......Page 335
References......Page 336
1. Introduction......Page 338
2. The Global Financial Crisis and Cross-Border Banking......Page 339
3.1 Current approach......Page 341
3.2 First-best option: a world financial regulator......Page 342
3.3 Second-best option: international bank charter......Page 343
3.4 A third-best option: decentralized but converged approach......Page 345
3.5 Another third-best option: enhanced coordination, including through colleges......Page 347
3.6 Fourth-best option: nationally segmented financial institutions......Page 348
References......Page 349
VII. How to Make Regulators and Government More Accountable: Regulatory Governance and Agency Design......Page 352
Making Safety-Net Managers Accountable for Safety-Net Subsidies Edward J. Kane, Boston College......Page 354
1. Role of Safety-Net Subsidies in Crises and Bubbles1......Page 356
2. Duties of Public Stewardship4......Page 360
2.1 Specifying duties that perfectly virtuous safety-net supervisors would embrace......Page 361
3. Fire! Ready, Aim — Reframing the Issue as Managing Safety-Net Subsidies......Page 364
4. Accountability Reform......Page 368
References......Page 369
Regulatory Governance and Agency Design: An Old Topic, Made Extra Relevant by the Financial Crisis Michael Klein, Johns Hopkins School of Advanced International Studies......Page 372
1. How Existing Regulatory Systems Coped with the Financial Crisis......Page 374
2. The Primacy of Market Structure......Page 376
3. Rules of Thumb for Financial Regulatory Agency Design......Page 377
4. Special Incentives for Regulators......Page 379
5. International Institutions......Page 380
6. What to Do to Get a Better Handle on the Issues......Page 381
References......Page 382
1. Introduction......Page 384
2. Governance Failures Contributed to the Crisis......Page 385
2.1 Credit default swaps and bank regulatory capital......Page 386
2.2 Credit rating agencies......Page 389
3. Dynamic Financial Innovation and Sluggish Financial Regulation......Page 392
5. The Sentinel......Page 393
6. Really? Another Institution?......Page 396
References......Page 397
Holding Regulators and Government More Accountable: Comments R. Christopher Whalen, Institutional Risk Analytics......Page 400
References......Page 406
VIII. Policy Panel: Where Do We Go from Here?......Page 408
1. End “Too Big to Fail”......Page 410
1.1 Do no harm, or at least do no more harm......Page 412
2. Protect Consumers, Don’t Control Them......Page 413
3. Deliver Us from the Status Quo......Page 414
References......Page 415
1. Introduction......Page 416
2. Back to Basics......Page 417
3. Frictions Begat Leverage......Page 418
4. Some Guiding Principles for Regulatory Reform......Page 420
5. Some Specific Suggestions......Page 421
References......Page 423
Suggested Financial Structure for Developing Countries Justin Yifu Lin, World Bank......Page 424
Reference......Page 427
Comments on “Where Do We Go from Here?” Deborah J. Lucas, MIT Sloan School of Management......Page 428
References......Page 432
Where to from Here? Have the Rules of Finance Changed? John Silvia, Wells Fargo & Co.......Page 434
Conference Agenda......Page 438
Index......Page 444