Managing Systemic Crises
On Tuesday the World Bank and IMF held a joint conference on Managing Systemic Crises and Redesigning Financial Systems. Check out presentations from heavyweights in the world of economics, including Luigi Zingales, Andrei Shleifer, and Daron Acemoglu.
It's also worth checking out a presentation by Charles Calomiris in which he discusses why we need macro-prudential regulation as a complement to micro-prudential discipline:
- Because of agency problems, pricing of risk on buy side is not always accurate.
- The combination of monetary policy looseness and agency problems can create incentives to ride a bubble.
- Market discipline is not enough under these circumstances; there needs to also be a belt on top of the suspenders, because of agency problems.
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I am a former Executive Director of the World Bank and many in the WB know I have been one of the most vociferous critics of the regulations coming out from Basel, especially with reference to development; and so I must first express some sadness about not having been invited or even alerted to this event. But, enough of that.
It was in order to “review the workings of the global financial systems and to explore ways and means to secure a more sustainable and just global economic order” that the President of the General Assembly convened the Commission of Experts, chaired by Joseph Stiglitz.
In their recommendation in paragraph 56 these experts state correctly that “Financial regulation must be designed so as to enhance meaningful innovation that improves risk management and capital allocation”.
Yet, not once do these experts even mention that the arbitrary minimum capital requirements based on one single dimension of risk actually represent the mother of all regulatory interventions in the capital allocation mechanisms of the markets… and which was one of the primary causes of why, over a period of less than three years, about 2 trillion dollars, more than the sum of all development bank lending over the years, went over the precipice of the extremely poorly awarded mortgages to the subprime housing sector in the US.
And neither do the experts say a word about the fact that these capital requirements instruct a bank to hold minimum equity for each 100 dollars lent by a bank to a sovereign country, depending on the credit rating as follows: AAA to AA = $0, A+ to A-= $1.6, BBB + to BBB- = $4, BB + to B-= $8, Unrated =$8 and Below B-= $12; and which since lower rated sovereigns will anyhow be paying market rates that are considerably higher than what the better rated sovereigns pay, implies that the differences in capital requirements amount to an additional arbitrary tax on risk; which subsidizes anything better able to dress up as risk-free and penalizes anything expected to be perceived as more risky. Some would argue that this does not amount to any discriminatory protectionism as these criteria are applied across the whole globe, but that argument ignores the fact of how the perceived riskiness is unequally distributed around the globe.
Honestly, since risk is the oxygen of development how can the experts ignore such a financial discrimination of risk and development?
Posted by: Per Kurowski | Jun 3, 2009 1:30:15 PM