Understanding Systemic Risk in Global Financial Markets

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Gottesman Aron. Understanding Systemic Risk in Global Financial Markets

Preface

Acknowledgments

About the Authors

CHAPTER 1. Introduction to Systemic Risk

WHAT IS SYSTEMIC RISK?

SYSTEMIC RISK DRIVERS

WHY SYSTEMIC RISK MUST BE UNDERSTOOD, MONITORED, AND MANAGED

KEY POINTS

CHAPTER 2. How We Got Here: A History of Financial Crises

INTRODUCTION

COMMON DRIVERS OF HISTORICAL CRISES

INTERNATIONAL CONTAGION

KEY POINTS

CHAPTER 3. The Credit Crisis of 2007–2009

INTRODUCTION

PLANTING THE SEEDS OF A BUBBLE: THE EARLY 2000s

WALL STREET'S ROLE

THE U.S. GOVERNMENT TAKEOVER OF THE GSEs

THE TIPPING POINT: LEHMAN BROTHERS' FAILURE

AFTERMATH OF THE CREDIT CRISIS

COST OF GOVERNMENT BAILOUTS

KEY POINTS

CHAPTER 4. Systemic Risk, Economic and Behavioral Theories: What Can We Learn?

INTRODUCTION

MINSKY THREE-PART MODEL

DEBT DEFLATION CYCLE

BENIGN NEGLECT

BEHAVIORAL THEORIES

RISK AVERSION BIAS

ASSET PRICES

HOMOGENEOUS EXPECTATIONS VERSUS HETEROGENEITY

KEY POINTS

CHAPTER 5. Systemic Risk Data

INTRODUCTION

KEY DATA ATTRIBUTES

KEY POLICY CHANGES TO ADDRESS DATA GAPS

DATA SOURCES

DATA COLLECTION CHALLENGES AND REMAINING GAPS

MOVE TOWARD STANDARDIZATION: LEGAL ENTITY IDENTIFIER INITIATIVE

KEY POINTS

CHAPTER 6. Macroprudential versus Microprudential Oversight

INTRODUCTION

A COMPARISON OF MACROPRUDENTIAL VERSUS MICROPRUDENTIAL

MICROPRUDENTIAL POLICIES

MACROPRUDENTIAL POLICIES

A HISTORICAL PERSPECTIVE ON MACROPRUDENTIAL TOOLS

CHOICE OF MACROPRUDENTIAL POLICY TOOLS

KEY POINTS

CHAPTER 7. Introduction to the U.S. Regulatory Regime

INTRODUCTION

WHO ARE THE REGULATORS?

U.S. REGULATORY APPROACHES

COMPARISON OF U.S. VERSUS INTERNATIONAL FINANCIAL REGULATORY REGIMES

INTRODUCTION TO THE DODD-FRANK ACT

KEY POINTS

CHAPTER 8. Introduction to International Regulatory Regimes

INTRODUCTION

THE FINANCIAL STABILITY BOARD

THE BASEL ACCORDS

THE EUROPEAN SYSTEMIC RISK BOARD

PRINCIPLES FOR FINANCIAL MARKET INFRASTRUCTURES

CHAPTER 9. Systemically Important Entities

INTRODUCTION

INTRODUCTION TO SYSTEMICALLY IMPORTANT ENTITIES

CLASSIFICATION OF ENTITIES AS SYSTEMICALLY IMPORTANT BY THE FSOC

GLOBALLY SYSTEMICALLY IMPORTANT BANKS

BROAD IMPACT OF FINANCIAL STABILITY REQUIREMENTS

CHAPTER 10. The Volcker Rule

INTRODUCTION

INTRODUCTION TO THE VOLCKER RULE

THE VOLCKER RULE: DETAILS

IMPLEMENTATION OF THE VOLCKER RULE

VOLCKER RULE: CRITICISM

CHAPTER 11. Counterparty Credit Risk

INTRODUCTION

OVERVIEW OF DERIVATIVE SECURITIES

COUNTERPARTY EXPOSURE

HOW COUNTERPARTY CREDIT RISK IS MANAGED

COUNTERPARTY CREDIT RISK AND SYSTEMIC RISK

KEY POINTS

CHAPTER 12. The Dodd-Frank Act and Counterparty Credit Risk

INTRODUCTION

MEASURING COUNTERPARTY EXPOSURE IN THE OTC DERIVATIVES MARKET

OVERVIEW OF HISTORICAL DATA

THE EVOLUTION OF THE U.S. REGULATORY APPROACH TOWARD OTC DERIVATIVES

KEY PROVISIONS OF TITLE VII OF THE DODD-FRANK ACT

CRITICISM OF TITLE VII OF THE DODD-FRANK ACT

KEY POINTS

CHAPTER 13. The Basel Accords

INTRODUCTION

WHAT ARE THE BASEL ACCORDS?

THE APPROACH OF THE BASEL ACCORDS

BASEL I

BASEL II

BASEL III

THE CONTINUING EVOLUTION OF THE BASEL ACCORDS

KEY POINTS

CHAPTER 14. Lender of Last Resort

INTRODUCTION

LENDER OF LAST RESORT CONCEPT

HENRY THORNTON, WALTER BAGEHOT, AND ALTERNATIVE VIEWS

THE FED'S ROLE IN THE GREAT DEPRESSION

THE CREDIT CRISIS OF 2007–2009

KEY POINTS

CHAPTER 15. Interconnectedness Risk

INTRODUCTION

A CASE STUDY OF INTERCONNECTEDNESS

INTERCONNECTEDNESS CATEGORIES

POST-CRISIS REGULATORY VIEW OF INTERCONNECTEDNESS

AN APPROACH TO ANALYZING INTERCONNECTEDNESS RISK

CHAPTER 16. Conclusion: Looking Ahead

IT'S NOT A QUESTION OF IF, BUT WHEN, WHERE, AND HOW

A SUMMARY OF GLOBAL SURVEYS

APPENDIX. Systemic Risk Models

INTRODUCTION

STRUCTURAL VERSUS REDUCED-FORM CREDIT MODELS

CONTINGENT CLAIMS AND DEFAULT MODELS

MACROECONOMIC MEASURES

PROBABILITY DISTRIBUTION MEASURES

ILLIQUIDITY MEASURES

COUNTERPARTY RISK MEASURES

Solutions to the Knowledge Check Questions

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Understanding Systemic Risk in Global Financial Markets

ARON GOTTESMAN

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Banking crises, another frequent driver of systemic events, may be defined as either the failure, takeover, or forced merger of one of the largest banks in each nation or, absent such corporate events, a large-scale government bailout of a group of large banks in that nation. Using this definition, there have been a tremendous number of banking crises that have occurred globally throughout history. Dating back to the year 1800, 136 countries have experienced some form of banking crisis.12

An important point to note is that banking crises have historically been intertwined with other categories of financial crises. For example, many banking crises have been fueled, at least in part, by the bursting of asset bubbles in real estate and national stock markets. However, many of these same bubbles were enabled by the banking sector itself as banks are often the main provider of credit and liquidity for real estate financing. This point is supported by the following statement:

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