For those of you interested in economics: "Bailing Out the Banks"

[wiegie]

Just downloaded this paper and I haven't finished reading it yet. I agree with most of what I have read so far though:

 

http://www.cepr.org/pubs/other/Bailing_out_the_banks.pdf

[Azazello1313]

I thought this was pretty good

 

Questions and Answers about the Financial Crisis*

Prepared for the U.S. Financial Crisis Inquiry Commission

Gary Gorton

Yale and NBER

February 20, 2010

Abstract

All bond prices plummeted (spreads rose) during the financial crisis, not just the prices of subprimerelated

bonds. These price declines were due to a banking panic in which institutional investors and

firms refused to renew sale and repurchase agreements (repo) – short-term, collateralized, agreements

that the Fed rightly used to count as money. Collateral for repo was, to a large extent, securitized

bonds. Firms were forced to sell assets as a result of the banking panic, reducing bond prices and

creating losses. There is nothing mysterious or irrational about the panic. There were genuine fears

about the locations of subprime risk concentrations among counterparties. This banking system (the

“shadow” or “parallel” banking system) -- repo based on securitization -- is a genuine banking system, as

large as the traditional, regulated and banking system. It is of critical importance to the economy

because it is the funding basis for the traditional banking system. Without it, traditional banks will not

lend and credit, which is essential for job creation, will not be created.

[Fatman]

Thanks Wiegie.

[Perchoutofwater]

Cliff Notes?

[geeteebee]

Man, that's a long paper. Before I spend a couple of hours reading it can you answer me this: after skimming the first couple of pages, it appears to be about European banks. Are there differences in the regulatory environment that don't allow their conclusions to be applied in the US? Basically, I don't want to read it and come away saying, "that's great for Europe and all, but it can't happen in the US because the system is different." I just don't know enough about the European banking system to know the answer. Thanks.

[cliaz]

Cliff Notes?

 

 

Give me a couple of minutes to at least read the dmn thing

[wiegie]

I thought this was pretty good

Haven't read it all yet, but that is very likely a GREAT find. Gorton is an expert on this panic.

[Ursa Majoris]

Haven't read it all yet, but that is very likely a GREAT find. Gorton is an expert on this panic.

It's very interesting. What it lacks is a suggestion on what is to be done.

[wiegie]

It's very interesting. What it lacks is a suggestion on what is to be done.

my standard suggestions are:

1) higher capital requirements for banks

2) a progressive fee that banks must pay as they become large enough to introduce systemic risk into the economy. This fee will provide a sort of insurance fund that can be tapped into for future bailouts and will, more importantly, discourage banks from becoming too large to begin with.

3) clearinghouses for various financial assets that are currently traded over-the-counter

Edited March 7, 2010 by wiegie

[whomper]

Give me a couple of minutes to at least read the dmn thing

 

 

[Azazello1313]

a progressive fee that banks must pay as they become large enough to introduce systemic risk into the economy. This fee will provide a sort of insurance fund that can be tapped into for future bailouts and will, more importantly, discourage banks from becoming too large to begin with.

 

does the fact that there are fewer, larger banks really introduce any greater systemic risk than if there were relatively more, smaller banks? after reading through that gorton thing, I'm not sure the answer is "yes". it seems like the fundamentals that created basically a run on banks wouldn't be much different either way.

 

and ursa, the sense I get from gorton, is that he doesn't really focus on what needs to be done now because it's not really important to his task. I am putting words in his mouth here big time, but his outlook seems to me to be that yeah, there were regulations and reforms (particularly FDIC) and they did some good preventing bank runs for several decades, but that eventually the money flows around and finds the path of least resistance and the risk is still going to pop up. regulators were there keeping an eye on things, but didn't see any of this coming. new regulation is always a reaction to the LAST crisis. but whatever the last crisis was would probably never happen again anyway, because everybody else would be keen to the sign posts as well.

[Ursa Majoris]

does the fact that there are fewer, larger banks really introduce any greater systemic risk than if there were relatively more, smaller banks? after reading through that gorton thing, I'm not sure the answer is "yes". it seems like the fundamentals that created basically a run on banks wouldn't be much different either way.

I got that sense as well but I think the answer to that might lie in leverage. Hundreds of small banks could have the same cumulative risk if you add them all up as five gigantic banks but they would not each have the leverage that each of the big ones would have, hence they would be less likely to fail in the same cataclysmic fashion. Maybe?

and ursa, the sense I get from gorton, is that he doesn't really focus on what needs to be done now because it's not really important to his task. I am putting words in his mouth here big time, but his outlook seems to me to be that yeah, there were regulations and reforms (particularly FDIC) and they did some good preventing bank runs for several decades, but that eventually the money flows around and finds the path of least resistance and the risk is still going to pop up. regulators were there keeping an eye on things, but didn't see any of this coming. new regulation is always a reaction to the LAST crisis. but whatever the last crisis was would probably never happen again anyway, because everybody else would be keen to the sign posts as well.

This issue could be addressed by the banks own quality control. His analogy to ecoli in tiny amounts causing a recall of all meat is very telling. The key to avoiding ecoli is quality control and inspection. In the banking scenario, the return and retention of tougher lending standards would be that quality control.

 

I wasn't quite sure why the haircuts became so significant suddenly - was there some trigger prior to the crisis itself that made investors demand more collateral for their deposits?

[Azazello1313]

Haven't read it all yet, but that is very likely a GREAT find. Gorton is an expert on this panic.

 

he has a book out: Slapped by the Invisible Hand: The Panic of 2007

 

from tyler cowen, "I also take his analysis to suggest (here this is my gloss, not his words) that there is no way to avoid crises since "bank run-like phenomena" can pop up in many different ways in any economy with significant liquidity transformation." pretty much what I said a few posts back.