2Table of ContentsPageI. Preamble3 II. Causes of the Crisis1. The Arbitraged Global Bond Market and the Housing Crisis3 2. Securitization of Subprimes: the Crisis Story Unfolds6 3. A Classic Euphoric Bubble Takes Hold8 4. Why Did the Boom Reach Such Heights?10 III. Financial Intermediation1. The Purpose of Finance13 2. Risky Financial Intermediation16 3. The Hundred Year Flood17 IV. Regulatory Reform1. Principles of Reform19 2. Upward Revisions of Economic Capital23 3. What Regulation Can Do26 4. Regulatory Capital History27 5. Limits to Regulatory Capital Requirements29 6. Too Big to Fail31 7. Regulations Embodying a Forecast Fail with Regularity34 V. Role of Monetary Policy1. Monetary Policy and House Price Bubbles37 2. Could the Breakdown Have Been Prevented?43 VI. In Summary46
3I. PreambleThe bankruptcy of Lehman Brothers in September 2008 precipitated what, in retrospect, is likely to be judged the most virulent global financial crisis ever. To be sure, the contraction in economic activity that followed in its wake has fallen far short of the depression of the 1930s. But the virtual withdrawal, on so global a scale, of private short term credit, the leading edge of financial crisis, is not readily evident in our financial history. The collapse of private counterparty credit surveillance, fine tuned over so many decades, along with the failure of the global regulatory system calls for the thorough review by governments now under way. The central theme of this paper is that in the years leading up to the current crisis, financial intermediation tried to function on too thin a layer of capital, owing to a misreading of the degree of risk embedded in ever-more complex financial products and markets. In sections II through V, this paper reviews the causes of the crisis. In sections VI to VIII, the nature of financial intermediation is probed; in sections IX to XV, a set of reforms that I hope address the shortcomings of the existing regulatory structure; in sections XVI and XVII, the role of monetary policy in the current crisis is examined; and section XVIII, the conclusion. II. 1. The Arbitraged Global Bond Market and the Housing CrisisIt was the global proliferation of securitized, toxic U.S. subprime mortgages that was the immediate trigger of the current crisis. But the roots of the crisis reach back, as best I can judge, to the aftermath of the Cold War.
has intentionally blurred sections.
Sign up to view the full version.