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Warding Off Financial Market Failure: How to Avoid Squeezed Margins and Bad Haircuts

Author

Listed:
  • David Longworth

    (Carleton University)

Abstract

Regulators aiming to ward off the next financial market failure need to implement rules to smooth the boom-bust cycle in margin requirements and haircuts used in securities financing and derivative transactions, which seriously exacerbated the last financial crisis. In this study, the author argues that key elements in a system-wide regulatory framework should include rules to mitigate swings between loose terms for margins and haircuts in boom times, and tightened terms during busts. Longworth emphasizes “through-the-cycle” haircuts and initial margins, the potential use of add-ons to haircuts and margins by macroprudential authorities, and market practices that are less procyclical than they were before and during the crisis.

Suggested Citation

  • David Longworth, 2010. "Warding Off Financial Market Failure: How to Avoid Squeezed Margins and Bad Haircuts," C.D. Howe Institute Backgrounder, C.D. Howe Institute, issue 135, December.
  • Handle: RePEc:cdh:backgr:135
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    References listed on IDEAS

    as
    1. Pierre Siklos & Andrew Spence, 2010. "Faceoff: Should the Bank of Canada Release its Projections of the Interest Rate Path? – The Cases For and Against," C.D. Howe Institute Backgrounder, C.D. Howe Institute, issue 134, October.
    2. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, pages 2201-2238.
    3. Allaudeen Hameed & Wenjin Kang & S. Viswanathan, 2010. "Stock Market Declines and Liquidity," Journal of Finance, American Finance Association, vol. 65(1), pages 257-293, February.
    4. Dave Sawyer & Carolyn Fischer, 2010. "Better Together? The Implications of Linking Canada-US Greenhouse Gas Policies," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 307, August.
    5. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York.
    6. Philippe Bergevin & David Laidler, 2010. "Putting Money Back into Monetary Policy: A Monetary Anchor for Price and Financial Stability," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 312, October.
    7. Jotham Peters & Chris Bataille & Nic Rivers & Mark Jaccard, 2010. "Taxing Emissions, Not Income: How to Moderate the Regional Impact of Federal Environment Policy," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 314, November.
    8. John Geanakoplos, 2009. "The Leverage Cycle," Cowles Foundation Discussion Papers 1715R, Cowles Foundation for Research in Economics, Yale University, revised Jan 2010.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Philippe Bergevin & William B.P. Robson, 2011. "The Costs of Inflexible Indexing: Avoiding the Adverse Fiscal Impacts of Lower Inflation," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 322, February.
    2. Nikil Chande & Nicholas Labelle, 2016. "Using Speed and Credit Limits to Address the Procyclicality of Initial Margin at Central Counterparties," Discussion Papers 16-18, Bank of Canada.
    3. Colin Busby & William B.P. Robson, 2011. "A Social Insurance Model for Pharmacare: Ontario's Options for a More Sustainable, Cost-Effective Drug Program," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 326, April.
    4. Finn Poschmann, 2011. "What Governments Should Do in Mortgage Markets," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 318, January.
    5. Bev Dahlby & Ergete Ferede, 2011. "What Does it Cost Society to Raise a Dollar of Tax Revenue? The Marginal Cost of Public Funds," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 324, March.
    6. Steve E. Hrudey, 2011. "Safe Drinking Water Policy for Canada - Turning Hindsight into Foresight," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 323, February.
    7. Thorsten V. Koeppl, 2011. "Time for Stability in Derivatives Markets – a New Look at Central Counterparty Clearing for Securities Markets," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 329, May.
    8. Sever, Can, 2014. "Systemic Liquidity Crisis with Dynamic Haircuts," MPRA Paper 55602, University Library of Munich, Germany.
    9. Christopher Ragan, 2011. "Precision Targeting: The Economics – and Politics – of Improving Canada’s Inflation-Targeting Framework," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 321, February.
    10. John Richards, 2011. "Aboriginal Education in Quebec: A Benchmarking Exercise," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 328, April.
    11. James P. Bruce, 2011. "Protecting Groundwater: The Invisible and Vital Resource," C.D. Howe Institute Backgrounder, C.D. Howe Institute, issue 136, February.
    12. Pierre Fortin, 2011. "Staying the Course: Quebec's Fiscal Balance Challenge," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 325, March.
    13. Paul Jenkins & Gordon Thiessen, 2012. "Reducing the Potential for Future Financial Crises: A Framework for Macro-Prudential Policy in Canada," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 351, May.
    14. Alexandre Laurin & William B.P. Robson, 2011. "A Faster Track to Fiscal Balance: The 2011 Shadow Budget," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 320, February.
    15. David A. Dodge & Richard Dion, 2011. "Chronic Healthcare Spending Disease: A Macro Diagnosis and Prognosis," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 327, April.
    16. David Longworth, 2012. "Combatting the Dangers Lurking in the Shadows: The Macroprudential Regulation of Shadow Banking," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 361, September.

    More about this item

    Keywords

    Financial Services; global financial crisis; regulatory framework; capital and leverage requirements; liquidity requirements; rules on margins and haircuts; financial insturments; collateral; loan-to-value ratios;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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