Financial Stability News

News about financial stability, central banking and theory of money

Monthly Archives: March 2012

Dallas Fed: End too-big-too-fail NOW

Dallas Fed Governor Richard W. Fisher has been very vocal on the TBTF issue, lastly in a speech in November last year where he wanted to “get an international accord that would break up these institutions”.

Now the annual report for 2011 is out for Dallas Fed and it is in its entirety devoted to the TBTF issue; title of the report: Choosing the Road to Prosperity – Why we must end too big to fail – NOW. Quote:

As a nation we face a distinct choice. We can perpetuate too big to fail, with its inequities and dangers, or we can end it. Eliminating TBTF won’t be easy, but the vitality of our capitalist system and the long-term prosperity it produces hang in the balance.

Two very interesting conferences

INET is hosting its second conference in Berlin shortly: Paradigm Lost: Rethinking Economics and Politics

The program is broad with a host of good speakers. By invitation only, but they usually post a lot of video.

Levy Institute will also host its 21st Annual Hyman P. Minsky Conference: Debt, Deficits, and Financial Instability at around the same time in NY City

with Gillian Tett, Claudio Borio, Andrea Enria, Peter Praet, Christine Cumming, Martin Wolf, Joseph Stiglitz among others.

Should be greatly interesting! Will keep you posted. Conference website is here.

Shadow banking in all channels

Shadow banking was the theme of a recent speech by FSA chairman Adair Turner. He noted in the Cass Lecture 2012 that (p. 21)

“the shadow banking system can create forms of ‘private money’ held either by the non-financial real economy or by intermediate financial institutions, in a fashion analogous to the banking system’s own creation of deposit money. And wherever there is maturity transformation and private money creation, there is a potential for runs. 

And to … make the banking system safe we will need to control the extent to which banks can provide such liquidity insurance to shadow banks. 

A key issue is whether shadow banks should be regulated as ordinary banks, and specifically whether they should have access to central bank liquidity facilities. Here the views are split among academics and policy makers.

The EU has issued its own Green paper of shadow banks and will host a conference on the topic end of April.

The IMF held a conference on the data needs of supervising shadow banks last fall: Casting Light on Shadow Banking: Data Needs for Financial Stability. The video is quite interesting, especially Paul Tucker from BoE, as usual very to the point.

The IMF hosted another regulatory seminar last friday March 23 (same time as the Fed conference, se previous post) on “The Financial System Five Years from Now”. No papers on the web yet, but program is posted here. Seems like an interesting day, with Buiter, Tarullo, Boot and Blanchard.

An interesting paper on Shadow banks posted last fall on the Harvard Law School Forum, called Shadow Banking and Financial Regulation. Short and to the point.

And there will be more coming. G20 and FSB has shadow banking (together with liquidity and trading book) on their agenda this summer, so expect much more on shadow banking in the months ahead.

And, if you want to really know what to do with the shadow banking problem, there will be a good working paper coming up shortly on the Levy Institute’s website. Should be up some time early April. Title: Shadow banking and the limits to central bank liquidity support. 

Fed conference on new central paradigm

Great conference at the Board of Governors last week: Central banking, before, during and after the crisis. “Everybody” was there, but unfortunately only by invitation. The program is out on the web, including Bernanke’s intro remarks, where he noted that:

“the events of the past few years pose serious challenges to the conventional, pre-crisis views and approaches of central banks and other financial supervisors”, and “we have much to learn about the workings and vulnerabilities of our modern, globalized financial system and its interactions with the broader economy”

Interesting papers by Gertler, Shin, Goodhart, Orphanides, Duffie and Aycharia (plus all the others “who is who” of academic central banking research). Should be worth the read.

No papers yet from the concluding discussion among Mervyn King, Caruana and Shirakawa, but obviously a lot to be discussed.

As Gillian Tett of the FT observed recently : “the crisis has tossed central banking into an intellectual limbo”.

Hopefully they found some of the answers in Washington DC last week!

Goodhart on how to prevent another banking crisis

Charles Goodhart and Enrico Perotti have an interesting VOX note on “Preventive macro prudential policy”. They suggest a five step PCA-like policy response with emphasis on liquidity and punitive charges for non-compliance with the Net Stable Funding ratio. National supervisors should be empowered to charge “prudential risk surcharges” on the gap between the banks’ current liquidity position and the new Basel III norms.

I am not so sure about the novelty of this, or how it would work. It resembles the old PCA framework, although transferred to a liquidity framework. Still interesting to read and could form the basis for some supplementary PCA reactions to the current capital based system.

For a review of the US experience with their PCA system during the latest crisis, see this report from the US Financial Stability Oversight Council. It was issued late 2011, but is still relevant for the ongoing discussion on how to prevent another banking crisis.

Banks drags heels on living wills

FT reports today that only one out of the 29 global banks that have been requested to have “living wills” ready by year end have finalized a draft recovery and resolution plan. Some more have completed just the recovery part, but progress here is uneven. The big European banks are lagging furthest behind. According to FT this may in part be due to regional differences, as supervisors are adopting different approaches towards banks.

FT also notes that banks find it particularly hard to foresee the regulatory reaction to a crisis situation, and they therefore have to guess for example how a particular national regulator will approach a branch in a crisis; will it be resolved locally or will it be resolved by the home supervisors. As long as these important issues remain unsettled (and they have been for many decades!), it is hard for banks to complete their living will process.

Bank managers as hired hands

Hyman Minsky has this beautiful description of the seeds of any banking crisis in his 1986 book Stabilizing an Unstable Economy. It is worth quoting in verbatim:


The typical professional bank president is not a rich man when he starts his career. As a bank president he is a hired hand trying to achieve personal fortune. But given the tax structure, it is difficult to accumulate a fortune by saving out of income; the most efficient route for a business executive is by way of stock options and the capital gains the accrue as the stock market price per share rises. As holders of stock options, bank management is interested in the price, on the exchanges, of their bank’s shares.
The price of any stock is related to earnings per share, the capitalization rate on earnings of the bank’s perceived risk class, and the expected rate of growth of such earnings. If bank management can accelerate the growth rate of earnings by increasing leverage without a  decrease in the perceived security and safety of the bank’s earning, then the price of share will rise because both earnings and the capitalization rate on earnings that reflects growth expectations rise. In a capitalist society with institutionalized organizations and tax laws such as ours, fortune-seeking by the mangers leads to an emphasis upon growth, which in turn leads to efforts to increase leverage. But increased leverage by banks and ordinary firms decreases the safety of margin and thus increases the potential for instability of the economy. [Minsky, 1986, p. 266]

And please note that this was written in 1982 (!) (the book was published in 1986). Martin Wolf has rightly described it as a masterpiece that provide the incomparably best account of the last financial crisis.

What to do?

Minsky noted that:

To control the disruptive influence that emanates from banking, it is necessary to set limits upon permissible leverage rations and to constrain the growth of bank equity to a rate that is compatible with noninflationary economic growth. This principle should guide policy, but in an economy in which new financial usages and institutions appear in response to profit opportunities, it is a principle that is much easier to state than to translate into practice. [ibid, p. 272] Indeed!

Keystone moving forward

Just a small news on the pipeline for those interested in the environmental degradation of the US mainland.

Keystone moving forward

Just a small news on the pipeline for those interested in the environmental degradation of the US mainland.