Engineering the Financial Crisis: Systemic Risk and the - download pdf or read online

By Jeffrey Friedman

ISBN-10: 0812243579

ISBN-13: 9780812243574

One of many lasting legacies of Reaganomics is a deep-seated mistrust of presidency intervention within the markets. regardless of this still-popular sentiment, the Basel Accords, a suite of foreign criteria for banking supervision and law, were the topic of remarkably little public feedback. whereas lecturers and practitioners decry the enforcement of the Sarbanes-Oxley Act on accounting reform or makes an attempt by way of Congress to manage government reimbursement, the Basel Accords were quietly accepted.In one of many first reports significantly to ascertain the Basel Accords, Engineering the monetary situation unearths the an important position that financial institution capital requisites and different govt laws performed within the contemporary monetary problem. Jeffrey Friedman and Wladimir Kraus argue that through encouraging banks to take a position in hugely rated mortgage-backed bonds, the Basel Accords created an overconcentration of danger within the banking undefined. furthermore, accounting rules required banks to lessen lending if the transitority marketplace price of those bonds declined, as they did in 2007 and 2008 through the panic over subprime loan defaults.The booklet starts by way of assessing best theories in regards to the crisis—deregulation, financial institution reimbursement practices, over the top leverage, "too monstrous to fail," and Fannie Mae and Freddie Mac—and, via cautious evidentiary scrutiny, debunks a lot of the traditional knowledge approximately what went mistaken. It then discusses the Basel Accords and the way they contributed to systemic possibility. ultimately, it offers an research of social-science services and the fallibility of economists and regulators. Engagingly written, theoretically artistic, but empirically grounded, Engineering the monetary obstacle is a well timed exam of the unintended—and occasionally disastrous—effects of rules on complicated economies.

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Extra resources for Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation

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79 percent (Pittman et al. 2008), nearly 30 percent higher than legal minimum for well-capitalized banks, and 60 percent higher than the ‘‘adequately capitalized’’ 8 percent level that was the absolute legal minimum for all banks. S. commercial banks’ aggregate conservatism before the crisis. Leverage is usually calculated by dividing total assets by what Basel I defined as ‘‘Tier 1’’ capital—funds received from sales of common equity shares and from retained earnings. Since these funds represent capital in the strictest and most secure sense, as explained in Chapter 2, Tier 1 capital is considered a truly reliable cushion against the unknowable future.

Each successively lower-rated tranche was subordinate to all the tranches above it. Therefore there was always, by definition, a triple-A or ‘‘senior’’ tranche (and sometimes even a ‘‘super-senior’’ tranche, which received payments before the ‘‘junior’’ triple-A tranche), because somebody—the owners of AAA-rated bonds—had to be the first recipient of the stream of revenue flowing from the pool’s mortgage payments. Looking at it from the bottom of the waterfall, if any of the mortgages in the entire pool defaulted, the sponsoring bank would suffer first by taking losses on the equity tranche, which it generally retained (‘‘equity’’ meaning ‘‘ownership’’ in financial contexts).

Special regulations have been imposed on commercial banks ever since deposit insurance was enacted in 1933, because of regulators’ fear of what would now be called ‘‘moral hazard’’: bankers might take advantage of the security blanket offered by deposit insurance to engage in reckless speculative activity. These regulations are the topic of Chapter 2. But since investment banks are not covered by deposit insurance, they have been much more lightly regulated than commercial banks. And it was investment banks that first attracted both investors’ and the general public’s attention to the crisis.

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Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation by Jeffrey Friedman


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