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Risk Reduction in the New Financial Architecture: Realities and Fallacies in International Financial Reform

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  • Martin Mayer
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    Abstract

    The causes for the instability that has marked the financial system over past decade lie deep-in the economic theory that urges easy and efficient substitution of one piece of paper for another, in the technology-driven tight articulation of receipts and payments, and in the growth of leverage that diminishes the creditworthiness of major institutions when an interruption in their receipts requires them to seek funds. Many of the proposals aimed at reducing risk in the financial system, however, do not recognize these changes or their importance. The call for greater bank transparency, for example, fails to take into account both that bankers and regulators are jealous of their "privacy" and that financial markets, not banks, have lately become the more important player in the financial system. Guidelines are needed that reflect the new financial architecture: controls on the creation of leverage in the repo and derivatives markets and limits on banks' freedom to back away from borrowers' cross-border liabilities in currencies other than their own. When such preventive measures fail, then crisis management will require "standstill" agreements to encourage the continuation of something like normal economic life while the losses from financial failure are sorted

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    Paper provided by Levy Economics Institute, The in its series Economics Public Policy Brief Archive with number ppb_56.

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    Handle: RePEc:lev:levppb:ppb_56

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    1. Michael D. Bordo & Bruce Mizrach & Anna J. Schwartz, 1995. "Real Versus Pseudo-International Systemic Risk: Some Lessons from History," NBER Working Papers 5371, National Bureau of Economic Research, Inc.
    2. Gregory R. Duffee and Chunsheng Zhou., 1999. "Credit Derivatives in Banking: Useful Tools for Managing Risk?," Research Program in Finance Working Papers RPF-289, University of California at Berkeley.
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