Fallacies, and Proposals"
BY: MARTIN MAYER
Brookings Institution
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=165550
Paper ID: Levy Institute Working Paper No. 268
Date: April 1999
Contact: Triveni Kuchi
Email: Mailto:kuchi at levy.org
Postal: The Jerome Levy Economics Institute
Bard College
Blithewood
Annandale-on-Hudson, NY 12504 USA
Phone: (914)758-7729
Fax: (914)758-1149
Paper Requests:
Contact Triveni Kuchi, Mailto:kuchi at levy.org Postal: Information
Specialist, The Jerome Levy Economics Institute, Bard College,
Blithewood, Annandale-on-Hudson, NY 12504. Phone:(914)758-7729.
Fax:(914)758-1149.
ABSTRACT:
Five times in a decade not yet completed, financial markets have
floated to the edge of a whirlpool; in October 1998 they were
about to drown when Alan Greenspan threw them a piece of string
that, surprisingly, turned out to be a lifeline. The causes for
this financial instability lie deep in the economic theory that
urges easy and efficient substitution of one piece of paper for
another, always and everywhere; in the technology-driven tight
articulation of receipts and payments that Hyman Minsky warned
against a generation ago; and in the growth of leverage that
diminishes the creditworthiness of major institutions when an
interruption in their receipts requires them to seek funds.
Meanwhile, as decision-making in finance moves from banks to
markets, and the creators of derivative instruments find ways to
present uncertainties as risks that can be modeled, time
horizons fall and spurious interrelations promote "dynamic
hedging" that communicates financial disturbance anywhere to
price volatility everywhere. Prevention should be sought in
rules to control the creation of leverage in the repo and
derivatives markets and in limits on banks' freedom to back away
from borrowers' cross-border liabilities in currencies other
than their own. Crisis management when prevention fails will
require "standstill" agreements to encourage the continuation of
something like normal economic life while the losses from merely
financial failure are sorted out.
JEL Classification: G21, G28