Crash of 2008: Difference between revisions

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The global financial crisis that may come to be known as "'''the Crash of 2008'''" was described by former Federal Reserve Bank Chairman [[Alan Greenspan]] as being a "once in a century credit  tsunami" <ref>[http://oversight.house.gov/documents/20081023100438.pdf Alan Greenspan in evidence to the House of Representatives Oversight and Government Reform Committee 23 October 2008]</ref>. It was triggered by the American  [[subprime mortgage crisis]], which infected much of the world's financial system and exposed its fragility. The credit shortage and general loss of confidence that followed contributed  to the severity of the developing [[recession of 2009]].
Governments in the United States and Europe have responded to the crisis by providing unprecedented amounts of financial support to their banking systems, and are considering measures to strengthen their regulation.
::''(for definitions of terms shown in italics in the following text, see the glossary on the [[/Related Articles|Related Articles subpage]].)''
== The crisis ==
After more than a decade of global financial stability and uninterrupted economic growth, the world economy has been seriously damaged by a banking crisis which started in 2007,  infected financial institutions throughout the industrialised countries in the course of 2008, generated a "credit crunch" that  deprived their industries of the financial support that they needed for continued growth, and threatened the continued prosperity of their inhabitants. That  banking crisis was the result of making bad investments with borrowed money on a scale that was only made possible by a relaxation of regulation in the 1980s and a major  increase in the complexity of the banks' investments in the following years. It was triggered by the bursting of  what is generally held to have been a "bubble" in the United States housing market that started in 2005 and  led, in the spring of 2007, to a downgrading of  the banks' holdings of bonds based upon mortgages made in that market, and to a widespread loss of confidence in their financial solvency. Failures of Bear Stearns and other major banks in the Summer of 2007 made the survivors extremely reluctant to lend to each other, and the  "''money market''", that had been their only other source of short-term borrowing, also dried up in the Autumn of 2008, following the unprecedent losses that the September failure of the Lehman Brothers  bank  inflicted upon its lenders. Deprived of those sources of finance, the remaining banks sought to hold on to what cash they had by severely limiting their loans to industries and prospective house buyers, leading in October to a widespread loss of confidence, and to cutbacks in spending for consumption and investment.
Throughout the second half of 2007 and the first three quarters of 2008,  governments in the United States and Europe  tried without success  to stem the developing  panic by ad hoc assistance to failing  banks, but in October they found themselves  forced to adopt general  schemes of support to their entire financial systems by injections of capital, the acquisition of stock in selected banks,  and the offer of guarantees on all bank lending. A cautious recovery of confidence was expected to follow.
:''(for a detailed account of the development of events in the United States housing market see the [[subprime mortgage crisis]] article; for a discussion of the risk-assessment mistakes that were made see the [[/Tutorials|Tutorials subpage]];  and for a month-by-month and day-by-day listing  of the sequence of events, with links to current news reports, see the [[/Timelines|Timelines subpage]])''
==Explanations==
A widely-held explanation of the crash treats it as a fallout from the United States [[subprime mortgage crisis]]. For example, the explanation offered in September 2008 by the United States government can be summarised as follows:
Inflows of money from abroad -- along with low interest rates --  enabled more United States consumers and businesses to borrow money.  Easy credit -- combined with the faulty assumption that house prices would continue to rise -- led  mortgage lenders there to approve  loans  without due regard to  ability to pay, and borrowers to take out larger loans  than they could afford. Optimism about prices also led to a boom in  which  more houses were built than people were willing to buy, so that  prices fell  and  borrowers -  with houses  worth less than they expected and payments they could not afford -  began to default. As a result, holders of  mortgage-backed securities began to incur serious losses, and those securities became so unreliable that they could not be  sold. Investment banks were consequently left with large amounts of unsaleable assets,  and many failed to meet  their financial obligations.  Arrangements for inter-bank lending went out of use, and banks through out the world  cut back upon lending <ref> [http://www.whitehouse.gov/news/releases/2008/09/20080924-10.html Summarised from  President Bush's television address of 25 September]</ref>.
Among other explanations was that forward by Charles Goodhart,  a former member of the Bank of England's monetary policy committee, portrays the crisis as "an accident waiting to happen"  that was triggered by the subprime crisis, but  could have been triggered by any of a variety of events. International organisations including the  [[International Monetary Fund]], and the [[Bank for International Settlements]], and most ''central banks''  had long been warning about what they saw as a serious underestimation of risks by  the financial system <ref> Charles Goodhart: "Explaining the Financial Crisis", ''Prospect'', February 2008 (based on a paper prepared for ''The Journal of International Economics and Economic Policy'', Vol 4 No 4) </ref>. Raghuram Rajan of the National Bureau of Economic Research had drawn attention to an increased willingness to take risks that had been brought about by the deregulation of the banking system  <ref>[http://www.kc.frb.org/publicat/SYMPOS/2005/PDF/Rajan2005.pdf Raghuram Rajan: ''Has Financial Development Made the World Riskier?'' , Working Paper No 11728, National Bureau of Economic Research September 2005]</ref>. Rewards based upon volume of funds under management had given rise to tendency for increased  risk-taking by traders, ''herding'' behaviour had encouraged that tendency, and  belief  that  their central bank would protect them from losses had encouraged complacency among managements. Also, a growing practice of concealing information relating to risks had increased the incidence of errors of risk assessment  by banks and their regulators. Banking regulators had failed  to avert the resulting danger, either because they  because they lacked the necessary regulatory instruments, or because of a lack of will. Central banks may have been reluctant to take corrective action by reducing interest rates when that would conflict with action to combat inflation.  On this view the underlying causes of the crisis were shortcomings of the regulatory systems, management failures by investment banks, and the conduct of banking regulators. A  more far-reaching reason for the crisis is implied by paper  by William White of the Bank for International Settlements
<ref name=White>William White:''Procyclicality in the Financial System: do we need a new macrofinancial stabilisation framework?'',BIS Working Paper No 193, Bank for International Settlements, January 2006[http://www.bis.org/publ/work193.pdf?noframes=1]</ref>, written before the outset of the crisis.  The paper  drew attention to a number financial and other "imbalances" (which the author  defined as significant and sustained deviations from historical norms) such as a historically low ratio of household saving and an historically  high level overseas indebtedness on the part of  the United States, and raised the possibility that their unwinding  could cause a financial and economic crisis. It also drew  attention  to the possibility that financial deregulation can lead to financial instability as  market participants and supervisors cope with unfamiliar circumstances. An implication of the paper  was a possibility that the market  system  itself might be prone to episodes of instablity.  However, none of those explanations  excludes the possibility that the severity of the 2008 crisis might have been increased by a number of factors other than those held to be mainly responsible.
==The principal causative factors==
===Regulation===
The fact that banks' assets, (which consist mainly of loans) amount typically  to twenty times the value of their shares, makes them especially vulnerable to  falls in the value of those assets. Governments have long been aware of the danger that a loss of confidence following the failure of one bank could lead to the failure of others, and eventually to "systemic failure" of the entire financial system. To limit that danger, they have traditionally  required  banks to limit the extent to which their loans exceed the funds provided by their shareholders  by the imposition of minimum "''reserve ratios''"  and have placed various other restrictions upon their activities.  In the 1980s, however, it was widely considered that those regulations  were imposing  excessive economic penalties, and there was a general move toward "deregulation" <ref>[http://www.bis.org/publ/econ43.pdf?noframes=1 Claudio Borio and Renato Filosa: ''The Changing Borders of Banking'', BIS Economic Paper No 43, Bank for International Settlements December 1994]</ref>. Restrictions that had prevented  investment banks from broadening  their activities to include  branch banking, insurance or mortgage lending were dropped, and reserve requirements were relaxed or removed. In the following years there were major  changes to banking practices, and they were followed by a series of banking crises <ref>[http://www.imf.org/external/pubs/ft/wp/wp97161.pdf Claudia Dziobek and Ceyla Pazarbasioglu: ''Lessons from Systemic Banking Restructuring: a Survey of 24 Countries'' Working Paper No 161, International Monetary Fund, 1997]</ref>. A study for the  [[Bank for International Settlements]] later concluded that deregulation  had left Spain, Norway, Sweden and the United States with regulatory systems that had been ill-prepared for the banking crises that they then encountered  <ref>[http://www.bis.org/publ/bcbs_wp13.pdf?noframes=1 ''Bank Failures in Mature Economies'', Working Paper No 13, Basel Committee on Banking Supervision, April 2004]</ref>.
In 1974  the governors of the central banks of the Group of Ten leading industrial countries had set up [[The Basel Committee for Banking Supervision]] <ref>[http://www.bis.org/bcbs/ The Basel Committee for Banking Supervision]</ref> to coordinate precautionary banking regulations <ref> See paragraph 5 of the article on [[Financial economics]]</ref>, and in 1988, concern about the increased danger of  systemic failure led that committee to publish a set of regulatory recommendations that related a bank's required reserve ratio to the riskiness of its loans <ref>[[http://www.bis.org/publ/bcbsc111.pdf?noframes=1, ''The Basel Capital Accord'' (Basel I) Basel Committe for Banking Supervision 1988]</ref>. In 1999 further  concern about the danger of instability led to the creation of the [[Financial Stability Forum]] <ref>[http://www.fsforum.org/index.htm The Financial Stability Forum]</ref>  to promote information exchange and international co-operation in financial supervision and surveillance. In 2004, the Basel Committee published revised recommendations known as Basel II <ref>[http://www.bis.org/publ/bcbsca.htm Revised International Capital Framework, (Basel II) Basel Committee on Banking Supervision 2006]</ref> intended to require banks to take more detailed account of the riskiness of their loans.
Other financial institutions are regulated by national authorities, including the Securities and Exchange Commission <ref>[http://www.economist.com/research/Backgrounders/displayBackgrounder.cfm?bg=986928 The [[Securities and Exchange Commission]] (''Economist backgrounder'')]</ref> in the United States, and the [[Financial Services Authority]] <ref>[http://www.economist.com/research/Backgrounders/displayBackgrounder.cfm?bg=1681180 The Financial Services Authority (''Economist backgrounder'')]</ref> in the United Kingdom. Until recently, however, restricted-membership ''hedge funds'' have escaped regulation, and those that are registered offshore continue to do so.
:''(for an account of the development of banking regulation, see the article on [[banking]])''
===Financial innovation===
Among major changes in banking practice that have developed since deregulation have been the growth of ''securitisation'', meaning the conversion of their loans into graded packages of bonds; and increased use of the strategy known as "originate and distribute", under which  such bonds were sold  to pension funds, insurance companies and other banks. The latter procedure removed the loans from the originating banks' balance sheets (thus improving their reserve ratios), but  continued to be their financial  responsiblity when – as often happened – they were transfered to their own ''hedge funds'' and to their specially-created ''structured investment vehicles''.
A longer-term development has been a gradual change in the funding of lending, away from ''liquid'' assets such as short term government bonds to private sector assets such as residential mortgages; also, there has recently been a hazardous trend toward increased ''leverage'' <ref>[http://www.bankofengland.co.uk/publications/fsr/2008/fsrfull0810.pdf ''Financial Stability Report'', Chart 1.9, Page 9, Bank of England, October 28 2008]</ref>, and an increase in the use of short-term ''interbank'' and ''money market'' borrowing  to pay for long-term loans.
:''(for an explanation of the importance to their stability of the banks'  use of leverage, see the article on [[banking]])''
A parallel development was a massive expansion of the unregulated organisations known as ''hedge funds'' – to the point at which they are estimated to have accounted for 40 to 50 per cent of stock exchange  activity by 2005
<ref>[http://www.bankofengland.co.uk/publications/fsr/2007/fsrfull0704.pdf ''Financial Stability Report'', p36, Bank of England April 2007]</ref> - many of which dealt in high-risk, high-return investments, and some of which used borrowed money amounting to over twenty times their capital.
:''(for more on changes in the practices of the finance industries see the article on the [[financial system]])''
===Attitudes to risk===
By early 2007 the regulatory authorities were expressing increased concern about banking attitudes to risk <ref>[http://www.fsa.gov.uk/pubs/plan/financial_risk_outlook_2007.pdf  ''Financial Risk Outlook 2007'', Financial Standards Authority January 2007]</ref> <ref>[http://www.bankofengland.co.uk/publications/fsr/2007/fsrfull0704.pdf ''Financial Stability Report'', Bank of England April 2007]</ref>. <ref>[http://faculty.chicagogsb.edu/raghuram.rajan/research/finrisk.pdf Raghuram Rajan: ''Has Financial Development Made the World Riskier?'' , Working Paper No 11728, National Bureau of Economic Research September 2005]</ref>
According to the [[Financial Stability Forum]], there had been an expansion "on a dramatic scale" of what they described as the "global trend of low risk premia and low expectations of financial volatility" <ref>[http://www.fsforum.org/publications/r_0804.pdf ''Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience'', International Monetary Fund 5th February 2008]</ref>. In their view, both the banks and the rating agencies had underestimated the risks to the banks' hidden subsidiaries that would result from an economic downturn, and the risks to the banks arising from their commitment to those subsidiaries. That had been due partly to the use of risk-management procedures that had been developed from experience with conventional investment products under normal circumstances, but were unsuitable for the predicting the value and risk of securitised products in times of significant economic difficulties; partly to a lack of access to the detailed information needed to independently value them in an accurate way; and partly to an incentive structure for fund managers which in effect rewarded them for taking risks.
:''(for more on the risk management errors, see the [[/Tutorials|Tutorials subpage]] and the [[Risk management]] article )"
===Credit rating errors===
Among the prinipal causes of the crash according to a presidential working group were "flaws in the credit rating agencies' assessments of subprime residential mortgage-based securities" <ref>[http://law.du.edu/images/uploads/presidents-working-group.pdf ''Policy Statement on Financial Market Developments'', by The President's  Working Group on Financial Markets, March 2008]</ref>, and a congressional  inquiry brought to light deficiencies in their rating methods 
<ref>[http://oversight.house.gov/story.asp?ID=2250 ''Hearing on the Credit Rating Agencies and the Financial Crisis'', Committee on Oversight and Government Reform, United States House of Representatives, October 22 2008]</ref> that prompted its chairman to describe their performance as a "colossal failure". Those statements  suggest that the credit rating agencies must  bear a major responsibility for the investment errors that led to the crash, but a report of interviews with international investment managers attending a London workshop has thrown some doubt upon that conclusion
<ref>[http://www.bis.org/publ/cgfs32.pdf?noframes=1 "Ratings in Structured Finance: what went wrong and what can be done to address shortcomings? '', Section 3, (Industry views) SCGFS Report No 32, Committee on the Global Financial System, Bank for International Settlements, July 2008]</ref>. The investment managers were reluctant to blame the agencies for the crisis because their shortcomings had been well  known, having been revealed by  their poor performance in anticipating the Asian banking crisis, and there had also been general awareness of the conflict of interest created by the fact that the agencies' principal source of income was payment by the issuers of the investments that they rated. Nevertheless it was thought likely that the  wider - and less well informed - body of investors had  been strongly influenced by mistaken ratings. The study group that reported on the interviews concluded that - although there had been other important reasons for their risk-management errors - credit ratings had exerted a significant influence on investors' decisions, and  that they had played an important part in the marketing prospectuses of the issuers of mortgage-backed securities.
:''(for more on the credit rating  errors, see the [[/Tutorials|Tutorials subpage]] )"
===The subprime mortgage crisis===
Serious problems in the United States  mortgage market emerged in 2005, and arrears and defaults grew throughout 2006. By the end of 2006 it was estimated that over two million households had either lost their homes or would do so in the course of the following two years <ref> 2006 Report of the Center for Responsible Lending (quoted in the 6th report of the House of Commoms Treasury Committee Session 2007-8, par 74 [http://www.publications.parliament.uk/pa/cm200708/cmselect/cmtreasy/371/371.pdf] </ref>, and that one in five subprime mortgages that had been taken out in the previous two years would end in foreclosure. The origins and causes of those problems are described in the article on the [[subprime mortgage crisis]]. Their consequences for the financial system arose from their effects upon the holders of mortgage-backed ''securitised'' products. Those products had been divided according to risk into a range of "tranches", each of which had been sold to a different category of investor, with the riskiest usually going to ''hedge-funds''  and others often going to pension funds and to banks' ''structured investment vehicles''. Early signs of crisis in the financial markets were the reports of problems at the government-sponsored enterprises (''Fannie Mae'' and ''Freddie Mac'') and at several  of  the major US banks <ref>[http://www.bankofengland.co.uk/publications/fsr/2008/fsrfull0810.pdf ''Financial Stability Report'', pages 18 and 19, Bank of England, October 28 2008]</ref>. In June 2007,  the Bear Stearns investment bank was placed in severe difficulties  by the need to rescue two of its hedge funds. By that time it was clear that the US housing boom had ended, and with falling house prices, there were accelerating mortgage foreclosures <ref>[http://thenumbersguru.blogspot.com/2008/09/mortgage-foreclosures-in-us-april-2007.html. ''Mortgage Foreclosures April 2007 to August 2008'', The Numbers Guru, September 2008]</ref>  A rumour circulated that, in addition to tranches of securitised subprime mortgages,  higher-grade tranches were also affected, and the mood of uncertainty spread from the subprime market to affect the markets for all types of asset-backed securities.
<ref> The evidence on which this paragraph is based is set out in detail in paragraphs 73-80 of  6th report of the House of Commoms Treasury Committee Session 2007-8, [http://www.publications.parliament.uk/pa/cm200708cmselect/cmtreasy/371/371.pdf]  and the Bank of England's October 2008 Financial Stability Report [http://www.bankofengland.co.uk/publications/fsr/2008/fsrfull0810.pdf]</ref>.
:''(this topic is dealt with in more detail in the article on the [[subprime mortgage crisis]])''
==Consequences==
===The credit crisis===
On 9th  August 2007, a French investment bank, BNP Paribas, suspended withdrawals from three of its hedge funds on the grounds  that it had become impossible to value their mortgage-backed assets. That announcement was immediately followed by the virtual closure of the ''interbank markets'' that banks had used to borrow from each other.  Banks that had relied upon that source for short-term funding found themselves in difficulties. An early victim was the UK's Northern Rock bank, which had relied upon those sources for 80 per cent of its funding. It was supported by short-term loans from the Bank of England, but news of that support panicked its depositors and provoked a traditional "run on the bank" as they rushed to withdraw their deposits. The crisis was further aggravated by banks' attempts to restore their reserve ratios after global capital writeoffs of about $500 billion, and by the middle of 2008 it was being said that "everyone wants to borrow and no-one wants to lend". In September 2008 a further source of credit dried up as the ''money market'' took fright after suffering unprecedented losses from the bankruptcy of Lehman Brothers.  Commercial companies other than banks came to be affected with the abandonment of the practice of ''rolling over'' maturing loans; and, by September, even major firms such as AT&T were finding it impossible to borrow money by  selling their  ''commercial paper'' that was repayable after periods  longer than a day. Prospective householders were also affected as mortgage approvals plummetted.
:''(further developments on this topic are to be considered in the article on the [[financial system]])''
===Economic costs===
It may prove to be difficult to distinguish the economic consequences of the crash from those of the preceding trends in the  markets for food and fuel, but there can be no doubt that it is making matters a great deal worse. It can be argued that fall  in house prices was no more than the end of a speculative bubble, but it is safe to assume that it hastened the downturn and added greatly to its severity. The full story is unlikely to become apparent for some years, but the major falls in investor, consumer and business confidence that occurred  in 2008 prompted forecasts of  substantial reductions in economic growth in all developed economies<ref> [http://www.imf.org/external/pubs/ft/weo/2008/02/pdf/text.pdf. In October 2008 the IMF forecast a fall in the growth rate of the "advanced economies" from 2.6% in 2007 to 0.5% in 2009, and a rise in unemployment from 5.4% to 6.5%]</ref>. But, although they consider that the scale of the  financial crisis may well be broadly comparable with  that of  the (very different) [[crash of 1929]] , most economists do not anticipate a [[recession]] as severe or prolonged as the [[Great Depression]],  on the presumption that the damaging policy responses of the 1930s will not be repeated <ref>[http://www.econ.berkeley.edu/~eichengr/now_great_depress_9-23-08.pdf Barry Eichengreen: ''And Now the Great Depression'', RGE Monitor, September 2008.]</ref>
:''(an account of subsequent economic developments is being made available in the article on the [[recession of 2009]])''
==Remedies==
===Rescue===
In the early stages of the crisis, the responses of governments and financial regulators were influenced by reluctance to reinforce the ''moral hazard'' under which the expectation of rescue had encouraged risk-taking. Where very large financial institutions were concerned, however, that consideration was often outweighed by fear of "systemic failure", and  that fear eventually  became the dominant influence on policy. Early policy changes included a relaxation of the conditions and terms of routine short-term loans from ''central banks''' ''discount windows'', and the more liberal exercise of their emergency powers to act as "lenders of the last resort"
<ref>[http://www.bankofengland.co.uk/publications/fsr/1999/fsr07art6.pdf  Xavier Freixas: ''Lender of the Last Resort: a review of the literature'' Bank of England Publications 1999]</ref>. Later measures included support to the ''money markets'' by the United States Government, widespread attempts to restore general levels of  financial ''liquidity'' and provision of additional capital to a series of failing banks.
Those proposals had little effect upon confidence and, towards the end of September it became evident to the United States authorities that it would not be sufficient to improve liquidity, nor to continue with ad hoc bank rescues. After initial misgivings, the Congress  came to  accept that the restoration of confidence depended upon the adoption of  more coprehensive measures  and on 3rd October it approved the  $700 billion "[[Paulson Plan]]" which gave the Treasury the power  (subsequently abandoned) to remove  "troubled assets" from American banks.  A few days later, the British Government announced a £500 billion rescue scheme <ref>[http://news.bbc.co.uk/2/hi/business/7658277.stm ''Rescue Plan for UK Banks Unveiled'', BBC News 8 October 2008]</ref>,  including powers to take equity stakes in ailing banks and an undertaking to guarantee interbank loans (that came to be known as the "Brown plan"); and a group of central banks announced a coordinated half per cent cut in their ''discount rates''. 
On October 10th the finance ministers of the "Group of Seven" leading industrial countries agreed a broadly-stated "action plan"  but failed to state their intention in concrete terms. However, in a reversal of his former intentions, the United States Treasury Secretary subsequently indicated a willingness to extend the "Paulson Plan" to include the acquisition of equity in US  banks <ref>[http://www.marketwatch.com/news/story/text-paulson-statement-equity-stake/story.aspx?guid={5AFA525A-2549-4146-BBC7-844249AF91A8}&dist=hplatest ''Text of Treasury Secretary Poulson's Statement on Taking Equity in US Banks'']</ref>, and, following a recommendation by Paul Krugman <ref>[http://www.nytimes.com/2008/10/13/opinion/13krugman.html?_r=1&oref=slogin Paul Krugman ''Gordon Does Good'' New York Times 12 October 2008]</ref>, plans were reported to have been set in motion to buy equity stakes in nine US banks. On the 12th of October, European Union leaders also agreed to pursue a rescue programme based upon the Brown plan, and on October 14th 2008, President Bush formally announced plans both to purchase equity in US banks, and to guarantee their loans <ref>[http://www.whitehouse.gov/news/releases/2008/10/20081014.html Presidential statement on the Economy 14th October 2008]</ref>, which was followed by  some tentative  signs of recovery in the ''interbank'' and ''money markets''.
:''(an account of the subsequent development and implementation  of rescue plans is to be included in the article on [[bank failures and rescues]])''.
===Reform===
===Reform===
A crippling of the world financial system that was triggered  by a  minority of defaults in a small corner  of  the United States economy  has been  seen as an reminder of that system's  inherent instability. The debate about measures to reduce that instability may be prolonged, but some proposals have already been put forward. In April 2008 the international [[Financial Stability Forum]] attributed the crisis to shortcomings in underwriting, firms' risk management practices, investor diligence, credit agencies' performance, staff incentives, disclosure practices, feedbacks between valuation and risk-taking, and regulatory effectiveness.  
A crippling of the world financial system that was triggered  by a  minority of defaults in a small corner  of  the United States economy  has been  seen as an reminder of that system's  inherent instability. The debate about measures to reduce that instability may be prolonged, but some proposals have already been put forward. In April 2008 the international [[Financial Stability Forum]] attributed the crisis to shortcomings in underwriting, firms' risk management practices, investor diligence, credit agencies' performance, staff incentives, disclosure practices, feedbacks between valuation and risk-taking, and regulatory effectiveness.  
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:''(recommendations for the improvement of financial risk-assessment are discussed on the [[/Tutorials|Tutorials subpage]], and  an account of further proposals for the reform of the financial system is to appear in the article on the  [[financial system]])
:''(recommendations for the improvement of financial risk-assessment are discussed on the [[/Tutorials|Tutorials subpage]], and  an account of further proposals for the reform of the financial system is to appear in the article on the  [[financial system]])
==References==
<references/>

Revision as of 13:41, 17 May 2009

Reform

A crippling of the world financial system that was triggered by a minority of defaults in a small corner of the United States economy has been seen as an reminder of that system's inherent instability. The debate about measures to reduce that instability may be prolonged, but some proposals have already been put forward. In April 2008 the international Financial Stability Forum attributed the crisis to shortcomings in underwriting, firms' risk management practices, investor diligence, credit agencies' performance, staff incentives, disclosure practices, feedbacks between valuation and risk-taking, and regulatory effectiveness. [1] They recommended regulatory changes under the headings of: strengthened prudential oversight of capital, liquidity and risk management, enhanced transparency and valuation, changes in the roles and uses of credit ratings, strengthening of the authorities’ responsiveness to risks, and robust arrangements for dealing with stress in the financial system. Another international study group has recommended measures to improve the performance of the credit rating agencies [2], but has also recommended that investors should not treat credit ratings as a substitute for conducting their own risk assessments. Charles Goodhart has proposed that bank capital requirements should be what he terms "contra-cyclical", meaning that they should be raised in times of boom and relaxed in downturns; and also related to the volume of lending [3], and William White has suggested that monetary policy should be directed to the objective of countering all economic imbalances </ref name=White>. Proposals for reform by Raghuram Rajan, Dani Rodrik, Willem Buiter and others, put forward in advance of the November meeting of the G20 world leaders, have been published as an ebook [4]. The proposals of the G20 leaders are set out in the article on the G20 summit.

(recommendations for the improvement of financial risk-assessment are discussed on the Tutorials subpage, and an account of further proposals for the reform of the financial system is to appear in the article on the financial system)
  1. ↑ Report of the Financial Stability Forum on Enhancing Market and Institutiona Resilience Bank for International Settlements April 2008
  2. ↑ "Ratings in Structured Finance: what went wrong and what can be done to address shortcomings? , Section 5, (Recommendations) SCGFS Report No 32, Committee on the Global Financial System, Bank for International Settlements, July 2008
  3. ↑ Charles Goodhart and Avinash Persaud How to Avoid the Next Crash, Financial Times, January 3 2008
  4. ↑ What G20 leaders must do to stabilise our economy and fix the financial system, voxeu.org, Centre for Economic Policy Research November 2008
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