This interview (gain access to hyperlink from here) was video-recorded with Michael Thompson in 2012. At the right time, Michael was the main Manager – Performance Measurement & Investment Management at USQ ICT. This video document will stream using the Windows Media Player (v.9, and above) and will play over the broadband (or better) connection. The document is not downloadable. You are able to pause, rewind, and fast-forward using the player’s control club. Some users have reported that whenever following the hyperlink in study-desk the Windows Media player opens in Study Desk, the video is large and the image quality is poor.
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Indeed, the reactions of regulators are disproportionate to the actions of financial markets consistently. In sinister dialectical fashion, the powers assumed and mistakes created by policymakers have a tendency to grow with each crisis, ? Fed’s policy reaction to the 1987 crash proportionate or even appropriate? Was it “an equal but opposite reaction” which merely temporarily stabilized financial markets or achieved it, in fact, implicitly expand the Fed’s regulatory role to managing equity prices? By late 1980s, an enormous part of the S&L industry was insolvent.
The downturn of 1990-91, made a bad situation worse. FSLIC funds were depleted. But a Federal guarantee is supposed to be that just, a guarantee, so Congress put a bailout package deal for the industry together. Have there been no moral hazard of guarantees, explicit or implicit, in the machine all these years, the shadow banking system could do not have grown into the regulatory nightmare it has become and liquidity regulation would be a non-issue.
Poorly capitalized banks could have failed from time to time but, absent the massive systemic linkages that such warranties have enabled-encouraged even-these failures would have been contained within a more dispersed and better capitalized system. As it stands, however, the regulators’ modus operandi remains unchanged. They continue steadily to deal with the unintended consequences of ‘misregulation’ with more misregulation, thereby ensuring that yet more unintended outcomes lurk in the foreseeable future. MIGHT COLLATERAL TRANSFORMATION IS THE CRUX OF ANOTHER CRISIS? In his speech, Governor Stein also quickly mentions collateral change, when low-quality security is asset-swapped for high-quality collateral. Naturally this isn’t done 1:1 but rather the low-quality collateral must be respected commensurately higher.
In certain respects these transactions act like traditional asset swaps that trade set for floating coupons and allow financial and non-financial businesses alike to manage interest rate and credit risk with greater flexibility. But in the full case of collateral change, what’s being swapped is the main and the credit rating it symbolizes, and one purpose of these swaps is to meet financial regulatory requirements for capital and, in future, liquidity.
Those finance institutions participating in the practice probably don’t see things this way. In the perspective of anybody institution swapping collateral in order to meet changing regulatory requirements, they see it as advisable and necessary risk management. But within a closed system, if most actors are behaving in the same way, the web risk is not then, in fact, reduced. The notion that it is, however, can be dangerous and can also contribute to banks unwittingly underprovisioning liquidity and undercapitalizing against risk.
Viewed system-wide, therefore, collateral change really represents a kind of financial alchemy rather than financial anatomist just. It adds no value in aggregate. It could even detract from such value by rendering opaque risks that would otherwise be more immediately apparent. THEREFORE I do understand the regulators’ concerns with the practice.
I don’t, however, subscribe to their proposed self-serving remedies for what they understand as yet another form of market failing. Am I exaggerating here? The regulators don’t view it that real way of course. Everywhere they look, they see market failure. Neo-Keynesians will deny this, claiming that their models take money and credit into account. But they do so only to an extremely limited extent, with financial crises relegated to mere aberrations in the data.