Connectedness and contagion : protecting the financial system from panics / Hal S. Scott.

Format:

Book

Author/Creator:

Scott, Hal S., author.

Language:

English

Subjects (All):

Financial crises--History--21st century.

Financial crises.

Global Financial Crisis, 2008-2009--Government policy.

Global Financial Crisis, 2008-2009.

Government policy.

History.

Physical Description:

1 online resource (xxi, 416 pages)

Place of Publication:

Cambridge, Massachusetts : The MIT Press, [2016]

System Details:

text file

Summary:

"The Dodd-Frank Act of 2010 was intended to reform financial policies in order to prevent another massive crisis such as the financial meltdown of 2008. Dodd-Frank is largely premised on the diagnosis that connectedness was the major problem in that crisis -- that is, that financial institutions were overexposed to one another, resulting in a possible chain reaction of failures. In this book, Hal Scott argues that it is not connectedness but contagion that is the most significant element of systemic risk facing the financial system. Contagion is an indiscriminate run by short-term creditors of financial institutions that can render otherwise solvent institutions insolvent. It poses a serious risk because, as Scott explains, our financial system still depends on approximately $7.4 to $8.2 trillion of runnable and uninsured short-term liabilities, 60 percent of which are held by nonbanks. Scott argues that efforts by the Federal Reserve, the FDIC, and the Treasury to stop the contagion that exploded after the bankruptcy of Lehman Brothers lessened the economic damage. And yet Congress, spurred by the public's aversion to bailouts, has dramatically weakened the power of the government to respond to contagion, including limitations on the Fed's powers as a lender of last resort. Offering uniquely detailed forensic analyses of the Lehman Brothers and AIG failures, and suggesting alternative regulatory approaches, Scott makes the case that we need to restore and strengthen our weapons for fighting contagion"--Provided by publisher.

Contents:

I Connectedness, Contagion, and Correlation: Definitions and a Review of the Economic Literature

1 The Concept of Connectedness 3

1.1 Asset Connectedness 3

1.2 Liability Connectedness 4

2 The Concept and History of Contagion 5

2.1 History of Contagion 6

2.2 Panicked Runs: Multiple Equilibria (Outcomes) 9

2.3 Information Economics 12

2.4 Measures of Systemic Risk 14

3 The Concept of Correlation 15

II Connectedness in the Crisis

4 Asset Connectedness: Lehman and AIG 19

4.1 Lehman Brothers' Collapse and Bankruptcy 19

4.2 Effects of the Lehman Collapse on Different Counterparties 24

4.2.1 Third-Party Creditors: Exposures and Expectations 25

4.2.2 Derivatives Counterparties: Exchange-Traded, CDS, and OTC Portfolios 30

4.2.3 Prime Brokerage Clients 47

4.2.4 Structured Securities Investors 48

4.2.5 Money Market Funds 50

5 Liability Connectedness: Money Market Funds and Tri-Party Repo Market 53

5.1 Money Market Funds and Liability Connectedness 54

5.2 Tri-Party Repo Market and Liability Connectedness 55

6 Dodd-Frank Act Policies to Address Connectedness 59

6.1 Central Clearing 59

6.2 Exposure Limitations 61

6.3 SIFI Designation 62

III Contagion

7 Contagion in the 2008 Crisis: The Run on the Nonbank Sector, "Shadow Banks" 67

7.1 Overview 67

7.2 Contagion after Lehman 71

7.2.1 Money Market Funds and Commercial Paper Markets 71

7.2.2 Interbank Lending and Repos 73

7.2.3 Investment Banks 74

7.3 Government Responses to the 2008 Contagion 75

8 History of Lender of Last Resort in the United States 79

8.1 First and Second National Banks 80

8.1.1 General Background and Powers 80

8.1.2 First Bank of the United States (1791-1811) 82

8.1.3 Second Bank of the United States (1816-1836) 84

8.2 Creation of the Federal Reserve System in 1913 and Its Authority as Lender of Last Resort to Nonbanks 88

9 Dodd-Frank Restrictions on the Lender-of-Last-Resort Power 93

9.1 Broad Program Requirement 94

9.2 Requirement of Approval by the Secretary of the Treasury 96

9.3 Loans Only to "Solvent" Institutions 101

9.4 Banks Cannot Use the Proceeds of Discount Window Loans to Make Loans to Their Nonbank Affiliates 104

9.5 New Collateral Policies Imposed on the Fed 105

9.6 Disclosure Requirements 106

10 Comparison of LLR Powers of Fed with Bank of England, European Central Bank, and Bank of Japan 109

10.1 Bank of England 109

10.1.1 Sterling Monetary Framework 110

10.1.2 Participation in the Sterling Monetary Framework and Acceptable Collateral 111

10.1.3 Discount Window Lending 112

10.1.4 Contingent Term Repo Facility Lending 113

10.1.5 Emergency Liquidity Assistance 114

10.1.6 ELA Assistance to Solvent Banks and Nonbanks 115

10.1.7 Lending at Treasury Direction 115

10.2 European Central Bank 116

10.2.1 Emergency Liquidity Assistance 116

10.2.2 ECB and European Commission Authority to Restrict NCB LLR 119

10.2.3 Liquidity via ECB Monetary Policy Operations 120

10.2.4 Long-Term Refinancing Operations 121

10.2.5 Purchasing Programs 122

10.3 Bank of Japan 122

10.3.1 Article 33 123

10.3.2 Article 38 124

10.3.3 Article 37 125

10.3.4 Article 44 126

10.4 Comparison of LLR Powers of the Four Central Banks 126

10.4.1 Independence 126

10.4.2 Ability to Lend to Nonbanks and Supervisory Authority 130

10.4.3 Regime Structure 130

10.4.4 Collateral 131

10.4.5 Requirement of Solvency 131

10.4.6 Treasury Approval or Direction 133

10.4.7 Need for a "Broad Program" 134

10.4.8 Disclosure Requirements 134

10.4.9 Using Discount Window Proceeds to Lend to Affiliates 135

11 Strengthening the LLR Powers of the Fed 137

12 Liability Insurance and Guarantees 145

12.1 Amount of Liabilities to Insure 148

12.2 Insurance Pricing 151

12.3 Ex ante Pricing 151

12.4 Option Pricing 154

12.5 Ex post Pricing 155

12.6 During a Crisis 157

12.7 International Challenges 157

13 Insuring Money Market Funds 161

Conclusion to Part III 165

IV Ex ante Policies to Avoid Contagion: Capital, Liquidity, Resolution, Money Market Mutual Fund Reform, and Limits on Short-Term Funding

14 Capital Requirements: Basel III Framework 169

14.1 Higher Basel III Capital Requirements 170

14.2 Surcharges for Globally Systemic ally Important US Banks 172

14.3 Risk-Weighted Assets Approach (RWA) 174

14.4 Leverage Ratio Approach 174

14.5 Tighter Definitions of Capital 176

14.6 Stress Tests 176

14.7 Calls for Even Higher Levels of Capital 177

14.8 Economic Impact of Capital Requirements 179

14.9 Role of Markets in Setting Capital Levels 180

15 Liquidity Requirements 183

15.1 Basel Liquidity Requirements 185

15.2 US Implementation of Basel Liquidity Requirements 186

16 Bank Resolution Procedures, Contingent Capital (CoCos), and Bail-Ins 189

16.1 Contingent Convertible Capital Instruments (CoCos) 190

16.1.1 Demand for CoCos 192

16.1.2 Conversion Triggers 192

16.2 Creditor Bail-ins by Regulators 194

16.2.1 Shortcomings of Bail-in outside Formal Resolution 196

16.2.2 Bailable Instruments and the Amount of Losses 197

16.2.3 Other Potential Obstacles to Bail-In 200

17 Dodd-Frank Orderly Liquidation for Nonbank SIFIs (Including Bank Holding Companies) 205

17.1 General Design of OLA and the SPOE Strategy 205

17.2 Total Loss Absorption Capacity (TLAC) to Assure Holding Company Recapitalization 208

17.3 Recapitalization of Operating Subsidiaries: Banks and Broker-Dealers 210

17.4 Derivatives Contracts 215

17.5 International Coordination Problems 216

18 Living Wills 219

19 Money Market Mutual Fund Reform 223

19.1 Enhanced Liquidity Requirements 224

19.2 The 2014 Reforms: Floating NAV, Redemption Fees, and Gates 225

19.3 Floating NAV 226

19.4 Liquidity Fees and Redemption Gates 227

19.5 Capital Requirement 229

19.6 Insurance 229

19.7 End of Public Institutional Prime MMFs? 230

20 Dependence of the Financial System on Short-Term Funding 231

20.1 Quantifying Short-Term Funding 231

20.1.1 Gross Funding 232

20.1.2 Net Funding 234

20.1.3 Importance of Short-Term Funding 235

20.2 Caps on Short-Term Funding 236

20.3 Indirect Limits on Short-Term Funding 237

21 Government Crowding Out of Private Issuance of Short-Term Debt 239

21.1 Crowding Out by the Treasury 239

21.2 Crowding Out by the Federal Reserve 241

21.2.1 General Overview of Fed's Tools of Monetary Policy 242

21.2.2 Interest on Excess Reserves and Reverse Repo Program 242

21.2.3 IOER and RRP Impact on Private Short-Term Debt Issuance 243

21.2.4 Size of the RRP Program 244

21.2.5 Potential Conflicts between Monetary Policy and Increasing the RRP Program to "Crowd Out" Private Short-Term Debt 245

21.2.6 Adverse Consequences of Partial and Full Crowding Out via RRP 247

V Public Capital Injections into Insolvent Financial Institutions

22 Capital Purchase Program and Other TARP Support Programs 251

22.1 Design of TARP 252

22.2 Expiration and Wind-Down of TARP 255

22.3 TARP Housing Programs Have Not Been Wound Down 261

23 Criticisms of Bailouts Generally 265

23.1 Taxpayer Loss 265

23.2 Bailouts May Not Work or Be Prolonged 267

23.3 Creation of Moral Hazard and Too-Big-to-Fail Competitive Advantage 268

23.4 Bailout Decisions May Be Political and Ad Hoc 270

23.5 Bailouts May Fail to Boost Lending Activities 271

24 Specific Criticisms of TARP 273

24.1 Too Favorable Terms for CPP Participants 273

24.2 Interference with Firm Operations 274

24.3 Lack of Enforcement of the CPP's Contractual Terms 275

24.4 Comparisons with Foreign Bailout Efforts in the 2008 Crisis 275

25 Standing Bailout Programs 279

25.1 Standing Bailout Programs in the European Union and Japan 279

25.1.1 Eurozone 279

25.1.2 Japan 281

25.2 Virtues of Standing Bailout Authority 284

26 Conclusion 287.

Notes:

OCLC-licensed vendor bibliographic record.

ISBN:

9780262332156

0262332159

9780262332149

0262332140

9780262332163

0262332167

OCLC:

949930490

Access Restriction:

Restricted for use by site license.