Risk Reduction in the New Financial Architecture: Realities, Fallacies, and Proposals
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.
|Date of creation:||20 May 1999|
|Date of revision:|
|Note:||Type of Document - Acrobat PDF; prepared on IBM PC; to print on PostScript; pages: 49; figures: included|
|Contact details of provider:|| Web page: http://econwpa.repec.org|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Allen N. Berger & Richard J. Herring & Giorgio P. Szego, 1995.
"The role of capital in financial institutions,"
Finance and Economics Discussion Series
95-23, Board of Governors of the Federal Reserve System (U.S.).
- 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.
- 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.
- Robert C. Merton, 1995. "Financial Innovation and the Management and Regulation of Financial Institutions," NBER Working Papers 5096, National Bureau of Economic Research, Inc.
- 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.
When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpma:9905003. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA)
If references are entirely missing, you can add them using this form.