Brian Romanchuk — The Financial Instruments Associated With Crises
This article is a continuation of previous comments on financial crises, with two lines of discussion. The first is a bit of a primer, explaining why I and other commentators associate financial crises with a buildup of private debt. The second part discusses the main problem with associating crises with private debt buildups: growth in debt stocks is by itself not enough to trigger a crisis. The catch is a variant of the efficient markets hypothesis: if we could easily forecast crises, it would be easy to outperform markets. However, other market participants are trying to do the same thing.…
Private sector financial crises are associated with private debt buildup. Unfortunately, we cannot expect simple rules based on debt growth to be able to accurately predict such crises.
2 comments:
As Laurence Kotlikoff rightly argues in a recent paper (link below), the build up of private debt is simply a CONTRIBUTORY element in financial crises. The basic cause of bank failures is the simple fact of funding loans via deposits or similar. I.e. if loans were funded just via equity, as per full reserve banking, it would be plain impossible for banks to fail. Even a decent rise in bank capital to about 20% as advocated by Anat Admati and Martin Wolf would make it NEAR impossible for banks to fail.
http://www.nber.org/papers/w25213
“it would be plain impossible for banks to fail.”
It would still be possible to fail if monetary policy added excessive reserve assets... ie reserves e assets that put banks in breach of regulatory total leverage ratio...
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