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Risk Reduction in the New Financial Architecture: Realities, Fallacies, and Proposals

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  • Martin Mayer

    (The Jerome Levy Economics Institute)

Abstract

Five times in a decade not yet completed, financial markets have floated to the edge of a whirlpool; in October 1998 they were about to drown when Alan Greenspan threw them a piece of string that, surprisingly, turned out to be a lifeline. The causes for this financial instability lie deep—in the economic theory that urges easy and efficient substitution of one piece of paper for another, always and everywhere; in the technology-driven tight articulation of receipts and payments that Hyman Minsky warned against a generation ago; and in the growth of leverage that diminishes the creditworthiness of major institutions when an interruption in their receipts requires them to seek funds. Meanwhile, as decision-making in finance moves from banks to markets, and the creators of derivative instruments find ways to present uncertainties as risks that can be modeled, time horizons fall and spurious interrelations promote "dynamic hedging" that communicates financial disturbance anywhere to price volatility everywhere. Prevention should be sought in rules to control the creation of leverage in the repo and derivatives markets and in limits on banks' freedom to back away from borrowers' cross-border liabilities in currencies other than their own. Crisis management when prevention fails will require "standstill" agreements to encourage the continuation of something like normal economic life while the losses from merely financial failure are sorted out.

Suggested Citation

  • Martin Mayer, 1999. "Risk Reduction in the New Financial Architecture: Realities, Fallacies, and Proposals," Macroeconomics 9905003, EconWPA.
  • Handle: RePEc:wpa:wuwpma:9905003
    Note: Type of Document - Acrobat PDF; prepared on IBM PC; to print on PostScript; pages: 49; figures: included
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    File URL: http://econwpa.repec.org/eps/mac/papers/9905/9905003.pdf
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    References listed on IDEAS

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    1. Berger, Allen N. & Herring, Richard J. & Szego, Giorgio P., 1995. "The role of capital in financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 393-430, June.
    2. Merton, Robert C., 1995. "Financial innovation and the management and regulation of financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 461-481, June.
    3. Michael Mussa & Morris Goldstein, 1993. "The integration of world capital markets," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 245-330.
    4. repec:wsi:rpbfmp:v:01:y:1998:i:01:n:s0219091598000053 is not listed on IDEAS
    5. Michael D. Bordo & Bruce Mizrach & Anna J. Schwartz, 1998. "Real versus Pseudo-International Systemic Risk Some Lessons from History," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 1(01), pages 31-58.
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    Cited by:

    1. Jean-Marc Boussard, 2001. "Assurances et marchés à terme: similitudes et différences," Économie rurale, Programme National Persée, vol. 266(1), pages 119-129.

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    JEL classification:

    • E - Macroeconomics and Monetary Economics

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