Last week’s publication of Michael Lewis’ Flash Boys has focused new attention on high-frequency trading (HFT). Fortunately, economic research has illuminated many issues associated with HFT, and recent work has proposed remedies that could limit the costs while retaining key benefits of HFT.
Read MoreCommentary
The Group of Seven is very upset with Russia for its treatment of Ukraine and its annexation of Crimea. So far, Europe and the United States are responding with various economic sanctions.
Sanctions can impose substantial pain on a country, cutting it off from the global economic and financial system. Such isolation would matter for Russia, which is a reasonably open economy. For example, its goods and services imports and exports are 22% and 29% of GDP, respectively.
Read MoreCentral bankers around the world agree that they should concern themselves with financial stability. They know that accommodative monetary policy aimed at bolstering growth and employment acts in part by encouraging borrowing, driving up asset prices and boosting risk taking. They also know it can go too far. And, when it does, credit booms turn into busts. Asset prices rise and then crash. Credit spreads narrow and then balloon. The result is defaults by households, firms, and intermediaries. On all of this everyone agrees.
Read MoreThe principles for designing a safe financial infrastructure are a bit like those for making a safe bridge or building. Safety-minded engineers should design the most critical components as simply and reliably as possible. They should use shock absorbers to reduce the frequency of failures, and establish backup mechanisms to limit their consequences.
Read MoreEveryone knows that leverage is a key driver of financial fragility. Since the crisis that began in 2007, regulators around the world have focused on limiting leverage to contain systemic risk, prompting many banks to raise capital and shrink their balance sheets.
Read MoreMany people criticize the way in which bank capital regulation is done. They know that banks can and do game complicated regulatory rules, a form of regulatory arbitrage. One focus of their criticism is risk weighting – the idea that banks should hold capital commensurate with the riskiness of their assets. The more risky the loans and securities a bank holds, the bigger the capital buffers should be to ensure that banks and the banking system are robust.
Read MoreOver the past few years, there has been frequent talk about the need for international coordination of monetary policies. In particular, central bankers outside the United States have urged the Federal Reserve to consider the impact of its policies on emerging market economies.
Read MoreThe CCP Advantage: Incentive and Means to Control Counterparty Risks
The case of the insurance giant, AIG, highlights the information and incentives problems that CCPs can address. In the run-up to the financial crisis, AIG’s London-based Financial Products Group managed to sell enormous amounts of credit risk insurance without the liquid resources necessary to cover potential cash calls. By end-June 2008, AIG had taken on $446 billion in notional credit risk exposure as a seller of credit risk protection via credit default swaps (CDS).
Read MoreExperience Shows CCPs Safer than OTC Trading
Experience both before and after the crisis revealed that the system of bilateral OTC derivatives transactions was far more fragile than experience with CCPs. As a result, many people began to advocate a shift to central clearing. And, the G20 leaders agreed.
Read MoreG-20 Leaders Vote for CCPs: What are they?
In September 2009, as the financial crisis was starting to slowly recede, the leaders of the twenty largest economies of the world (the G-20) met in Pittsburgh. At the end of their summit, they issued a communiqué of nearly 9000 words. Somewhere in the middle of the statement, the following sentence appeared:
All standardized OTC [over-the-counter] derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest.
Read More