Browse by Tags

Nouriel Roubini commends Congress for some of its recent reform efforts, but he does not believe that the federal government has done enough to avert financial crises in the future. The global economy remains highly vulnerable, and Roubini argues that not only the US government, but also the IMF, can do more to police systemic risk. He discussed his concerns about coming crises, during this Tea with The Economist :

William C. Dudley , President and Chief Executive Officer of the New York Fed , spoke yesterday at the Institute of International Bankers. Dudley shared his views on how to strengthen the financial system. He started by outlining what he sees as the basic cause of the crisis: Regulators and market participants failed to fully appreciate the degree to which the various aspects of our financial system are interconnected, and to foresee what those tight linkages would mean for market function when even one reasonably large institution—let alone many—became distressed. We also did not fully appreciate the strength of the amplifying mechanisms that were built into our financial system; the consequence of which was to exacerbate the boom on the way up and worsen the bust on the way down. Contributing to these pro-cyclical dynamics were inadequate incentives for firms to curb their risk-taking and to more effectively manage the risks they did face. The inadequate level of transparency and disclosure, particularly in the market for structured products, were also important in making the financial system more fragile and vulnerable to crisis and in increasing the degree of uncertainty and contagion once the crisis was underway. Dudley went on to outline a whole set of measures that might be taken to avoid the systemic risk that was central to the crisis. Among the more interesting ideas he discussed was the notion of introducing contingent capital instruments. These would be "debt instruments in “good” states of the world, but would convert into common equity at pre-specified trigger levels in “bad” states of the world," Dudley told the audience. Consider the advantages that such an instrument would have had during this crisis. Rather than banks clumsily evaluating whether to cut dividends, raise common equity and/or conduct exchanges of common equity for preferred shares and market participants uncertain about the willingness and ability of firms to complete such transactions and successfully raise new capital, contingent capital would have been converted automatically into common equity when market triggers were hit. If these contingent capital buffers were large, which they could be because the cost of these instruments should not differ much from straight debt, then the worst aspects of the banking crisis might have been averted. If shareholders had faced the potential of automatic and substantial dilution, they may have demanded better risk management and disclosure during the boom. If common equity had been automatically bolstered during the early part of crisis, investors would have been much less concerned about the risk of insolvency. Counterparty risk concerns would have been much less significant—potentially short-circuiting one of the important amplifying mechanisms of the crisis. Such instruments could have reduced the likelihood of failure of large, systemically important institutions, reducing the significance of the “too big to fail” problem and its associated moral hazard problems. Read the full speech here . (Hat tip to Mark Thoma for linking to the speech at Economists View ).

We're past the one-year anniversaries of the fall of Lehman Brothers and the near collapse of AIG, but the question over what we have learned from the crisis is bothering more than a few big economic thinkers and policy makers. Emma Bonino is Vice President of Italy's senate, and she concludes in today's Financial TImes that global leaders seem to have learned very little: As the saga of platitudes on the financial crisis comes to an end, hard questions now lie on the hands of world leaders. And the number of hands has expanded, with the Group of 20 leading nations set to replace the G7 and G8 as the hub of global economic co-operation. Economic giants, such as China, India and Brazil, will now have a voice in shaping world finance. This, of course, illustrates that decentralisation of economic power in the new world order is an unstoppable development, which may prove to be a positive one if the newcomers behave as responsible stakeholders. But will all this summitry really make a difference? With the benefit of hindsight we can see the flaws in the financial system that allowed the collapse of Lehman Brothers to bring the global economy to its knees. But will we be able to say we wised up and put in place a better financial system? Unlikely. So far, all we have really done is change the decision-making body, while the causes and symptoms of the financial crisis remain unchecked. Small and medium-sized banks continue to file for bankruptcy at a worrying pace. We still have not curbed the noxious behaviour of big banks: their social and political importance was enhanced more than scrutinised by the financial fallout after the Lehman disaster. “No more Lehmans” was the motto, cried both by banks and the public. The toxic combination of bank subsidies and bankers’ bonuses have socialised losses and privatised gains. Read What did we really learn from the financial crisis here . In the Washington Post, Simon Johnson and James Kwak argue that if we learned anything from the events of a year ago, the time to act is now. "The next couple of months will be crucial in determining the shape of the financial system for decades to come," they write. And they don't hold a lot of confidence in the Obama administration's ability to push through reform: We have criticized the administration's reform proposals, in particular for not going far enough to address the problem of financial institutions that are "too big to fail." But we support much of what was in the original package, particularly the CFPA and increased regulation of complex financial products. The question now is how hard Obama and Geithner will fight for it. Financial regulation, like health care reform, has entered the phase where speeches and proposals matter less than arm-twisting and horse-trading on Capitol Hill. With health care, President Obama attempted to go over the heads of Congress, directly to the American people. With financial regulation, that is no longer an option, given the extent to which it has faded from public consciousness. Read It's Crunch Time: The Fight to Fix the Financial System Comes Down to This here .