Back in 2002 Warren Buffet famously proclaimed that derivatives were ‘financial weapons of mass devastation’ (FWMDs). Time has proven this view to be appropriate. And will so-called ‘liquidity regulation’ avoid the next crisis? To answer these questions, John requires a closer take a look at proposed liquidity rules as a reply to the growing use of ‘collateral change’ (a topic often discussed here): the latest, ideal FWMD in the arsenal.

Back in 2006, as the controversy was raging whether or not the US had a home loan casing and credit bubble, I had a continuing, related exchange with the principle US Economist of a sizable US investment bank or investment company. It had to do with what is now commonly referred to as the ‘shadow bank system’.

While the controversy was somewhat arcane in its details, it boiled right down to if the additional financial market liquidity created through the use of securities repo and other kinds of collateralized lending were destabilizing the economic climate. THE PRINCIPLE US Economist experienced argued that, because US monetary aggregates weren’t growing at a historically raised rate, the Fed had not been adding liquidity gas to the home price inflation fire and that monetary plan was, therefore, appropriate. I countered by arguing that these other kinds of liquidity (eg. We resolved the controversy never. This specific Main US Economist experienced proved helpful at the Fed previously.

This was and remains true, in truth, of most senior US bank or investment company economists. Indeed, in addition to a PhD in one of the premiere US economics departments, a tour of responsibility at the Fed, as it were, has been the most important qualification for this role traditionally. As neo-Keynesian economists, they didn’t-and still don’t-have a coherent theory of money and credit. Time marches on and with lessons discovered harshly comes a fresh resolve to in some way get ahead of whatever might cause the next financial crisis.

Of the shadow banking system that, I believe, they still neglect to properly understand. ” which is central banker code for liquidity crises requiring action by central banks. He also makes specific mention of ‘collateral transformation’: when banking institutions swap collateral with one another. Why should this be so? Well, if interbank financing is increasingly collateralized by banks’ finest quality assets, then unsecured creditors, including depositors, are being de facto subordinated in the capital framework and are highly more likely to ‘run’ at the first symptoms of trouble.

And if banking institutions are keeping similar types of guarantee that abruptly fall in value, then they can all become at the mercy of a run at exactly the same time, for the same reason. Collateral transformation is thus a possibly powerful FWMD. But don’t worry, the BIS and other regulators are on the full case and doing the worrying.

  • Standard Tax Deduction
  • What do you own? Go over house, car, land, and location of game titles and paperwork of each
  • Fixed interest securities (also called bonds) – you loan your money to a company or authorities
  • 3 – Cash-back programs
  • Choose Finish
  • Awareness Phase,
  • 6 years ago from Sweden
  • Huge Financial Losses

As a belated response to the financial meltdown that they all failed to foresee, the latest, best trend in economic climate oversight is ‘liquidity regulation’. Ah yes, wouldn’t you understand it, that ubiquitous, iniquitous enigma: market failing. Regulators haven’t found market that doesn’t fail in some way, hence the crucial dependence on regulators to prevent the next failure or, at a minimum, to straighten out the subsequent clutter. But none of this was caused by ‘market failure’, as Governor Stein contends.

Rather, there is certainly another, simpler reason why banking institutions were provisioned against the chance of declining security beliefs insufficiently, yet it is not one which the regulators much prefer to hear, specifically, that their own plans were responsible. While relevant to the natural world, it generally does not hold with respect to the activities of financial marketplaces and the next reactions of central banks and other regulators.