Paths Taken and Paths Forward Ivan J Kirov Fed Challenge Feb 4 2010.
-
date post
19-Dec-2015 -
Category
Documents
-
view
224 -
download
1
Transcript of Paths Taken and Paths Forward Ivan J Kirov Fed Challenge Feb 4 2010.
Capital
• Savers• Investment vehicles
Financial Intermediation
• Banks• Financial Markets
Investment
• Firms• Entrepreneurs
The Financial System Financial Institutions
Solve informational asymmetry Leverage economies of scale
Bank “Self-Regulation”◦ At sign of trouble:
Creditors pull out Depositors withdraw Difficult to raise money in capital markets
Hence capital kept on hand
Banks are Businesses, Too
Discipline
Depositors
Creditors
Money Markets
Finance is systemically important to the functioning of the economy
…Then again, maybe not
Real Economy
TransmissionBanks
Financial Distress
- I- Y
- ΔY
Credit tightens Less Profitability and Growth
Liquidity (Lender of last resort)◦ Traditional purview of central banks
Deposit insurance◦ In US, from Depression
Creditor guarantees◦ Mostly from last crisis◦ AIG◦ Citi
Government Intervenes
Guarantees reduce risk in holding bank debt Moreover, they insulate creditors from loss
◦ Risk-taking proliferates Financial institutions’ incentives become out
of line with those of regulators
Moral Hazard
Source: Economist
Banks’ Equity as % of Assets
To avoid moral hazard implicit in support, governments impose financial regulatory structures
Animal Spirits Contained
Capital
• Structural security
• Asset buffer
Liquidity
• Rapid-response
• Psychological buffer
Pay
• Align incentives
• “Micro” buffer
Accounting
• Trans-border coordination
• Transparency
Basel-2: Current main international regulatory framework
Financial institutions must keep on hand at least 4% of risk-weighted assets◦ “On hand”: Tier-1 capital◦ “Risk-weighted”: According to GAAP, but in
practice a firm-specific definition
Problems◦ Tier-1 capital includes debt-like instruments◦ Low capital margin◦ Limited regulation of leverage
Basel-2
Originated by James Tobin in 1973 FX transactions above “optimal level” – tax
to bring them in line with public optimum.
Financial Tobin Tax is not strictly a form of regulation; more like enforced downsizing.
Problems:◦ How do governments know finance’s “optimal
size”?
Tobin Tax
Dec. 10, 2009: UK gov’t imposes 50% tax rate on bank bonuses exceeding £25,000
Largely politically motivated
Britain’s Bonus Tax
29%
40%
21%
10%
26-Jan-10
LabourConservativeLib-DemOther
Tax on financial firms with >$50 billion in assets
Would raise $90bn over 10 years To cover TARP fund Applies mostly to risky activities
◦ Proprietary trading desks
In practice: small, symbolic Principle?
Obama’s Bank Levy
Source: New York Times
Semi-reinstatement of Glass-Steagall
Banks (or just deposit-taking institutions?) cannot engage in proprietary trading or invest in hedge funds or PE funds
Details still pending Congressional crucible
Volcker Rule
Institution Estimated Revenue Loss
Goldman Sachs $4.5 bn
JPMorgan $2 bn
Citigroup ~ $500 milSource: New York Times
Work-in-progress: refinement of Basel-2 rules
General thrust◦ Safe “Tier 1” capital more narrowly defined (mostly
only equity)◦ Financial institutions cannot use proprietary risk
models◦ Liquidity: banks must withstand 30-day credit freeze◦ Capital requirements increased to 6-8% of risk-
adjusted assets
Basel-3
Liquidity regulation
Institutions pay for not-so-implicit guarantees
“Convertible capital”
Balance between institution-specific and system-wide regulation
Paths forward?
Julian Simon: The Dismal Science?
“One can hardly imagine, I think, how poor we would be today were it not
for the rapid population growth of the past to which we owe the enormous
number of technological advances enjoyed today. . . . If I could re-do the
history of the world, halving population size each year from the beginning
of time on some random basis, I would not do it for fear of losing Mozart
in the process.”
-Edmund S. Phelps
A Little Fun