vincent reinhart resident scholar the american enterprise institute may 13, 2009 jekyll island, ga
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Remarks on “International Exposure to U.S.-Centered Credit Market Turmoil” at the 2009 Financial Market Conference of the FRB Atlanta on “ Financial Innovation & Crises ”. Vincent Reinhart Resident Scholar The American Enterprise Institute May 13, 2009 Jekyll Island, GA. 1. - PowerPoint PPT PresentationTRANSCRIPT
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Remarks on “International Exposure to U.S.-Centered Credit Market Turmoil”at the 2009 Financial Market Conference of the FRB Atlanta on “Financial Innovation & Crises”
Vincent ReinhartResident Scholar
The American Enterprise InstituteMay 13, 2009
Jekyll Island, GA
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Maps of my comments
Organizational issue
Costs of crises
Geometry of financial regulation
Cautionary note
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Thanks to the organizers…For the nonjudgmental “&” in the title
As opposed to “Financial Innovation and its Evil Spawn Crises”
Crises have almost always been with us
Unless considerable restrictions on financial flows are in place
Unlike debt or inflation crises, they are prevalent over time and across different regimes
This suggests a dynamic game between the public and private sectors
Source: Reinhart and Rogoff (2009)
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The most expensive stage of a financial crisis
IS NOT the
Initiating economic shock
Magnification in financial markets
Policy missteps Forbearance Clean-up
IS When society writes the narrative
to describe what just happenedThe narrative determines the legislative and regulatory responseThis has been done wrong before. In the 1930’s, we “learned”
Fiscal policy is effective Monetary policy is not Competition can be excessive and Trade restrictions useful
Costs include stifling innovation and making the system too complicated and vulnerable when we unlearn those lessons
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Stijn Claessens is exactly right in focusing on the lessons learned from the crisis and their consequences for regulation
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The most useful metaphor for the problem of international financial regulation was written in 1884
Gave individuality to geometric concepts
Highlighted the difficulties of perspective and projection
Consider the plight of a 2D entity visited by a 3D object
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A national financial regulator…
Is a 2D entity observing a slice of a 3D large complex financial institution (LCFI)Taken together, our global system is one in which many regulators observe different slices of the same entity
With the slices taken at oblique anglesThe failure of oversight represents the failure of imagination
To visualize a complicated object properly
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From this perspective, consider Claessens’ policy alternatives
Coordination through a “college of regulators”
Converged approach with common frameworks
International banking charter
World financial authority
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A geometric explanation…
Coordination through a “college of regulators”
Converged approach with common frameworks
International banking charter
World financial authority
Pool the visualizations
Enforce a common shape at each cross section
Invent a higher dimensioned authority
Genesis worked because God started with a void
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A cautionary note…
A LCFI arrives at its overall shape by manipulating its appearance in each national slice
Tax avoidance Regulatory arbitrage Too-big-to-fail protection
The resultant entity is Quite complex in its full dimensionality Hard to visualize at a lower dimension Quite changeable from only a small rotation
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Practical consequence of this complexity
From the outside, an LCFI Hard to regulate
Leading authorities to be more likely to protect it Hard for the market to monitor, lessening
Shareholder oversight of management Counterparty discipline Takeover threat
From the inside, an LCFI Hard for management to supervise, creating
Incentive misalignments Suitability problems Compensation abuses
In a crisis, an LCFI Less resilient and subject to sharp changes in view as
objects turn and collide
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Plea for the under-explored alternative—simplification (converged approach)
Limit the number of standard charters by function
Have holding companies hold
Why? Easier to monitor
entities in regional slices Aligns incentives better Easier to identify and
protect systemically important parts, but not the whole
More costly
But so are all the alternatives
And the most likely alternative, a utility-regulatory model—will be very costly indeed by stifling innovation
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