Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de...
Transcript of Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de...
![Page 1: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/1.jpg)
SYSTEMIC RISK
Jean TIROLE
The Future of Financial Regulation
Banque de France - TSE conference January 28, 2009
![Page 2: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/2.jpg)
I. INTRODUCTION
(At least) two meanings of systemic risk:
(a) Domino e¤ectsCreated by:
� mutual exposures[OTC markets, money market, etc.]
� absence of centralized exchange[Amaranth 2006 vs. Lehman or AIG 2008].
Highly endogenous.Peer monitoring and domino e¤ects two sides of the same coin?
2
![Page 3: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/3.jpg)
(b) Overall macroeconomic fragility
X Increased reliance on markets (securitization, money market):
� traditional institutions (commercial banks, broker-dealers)� shift from bank-based system to market-based system (shadow bankingsystem: conduits, hedge funds, investment banks, monolines;mutual funds: threats of redemptions).
X Subprime borrowers, LBOs.
X Strong monetary policy reaction:
� $4,400 billion commitments through various Fed facilities� Fed funds rate almost 0.
3
![Page 4: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/4.jpg)
(b) Overall macroeconomic fragility
X Increased reliance on markets (securitization, money market):
� traditional institutions (commercial banks, broker-dealers)� shift from bank-based system to market-based system (shadow bankingsystem: conduits, hedge funds, investment banks, monolines;mutual funds: threats of redemptions).
X Subprime borrowers, LBOs.
X Strong monetary policy reaction:
� $4,400 billion commitments through various Fed facilities� Fed funds rate almost 0.
4
![Page 5: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/5.jpg)
Emmanuel Farhi-Jean Tirole"Leverage and the Central Banker�s Put" (AER P&P 2009)+ larger paper (in progress)
Transformation, interest rate vulnerability and monetary bailout
5
![Page 6: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/6.jpg)
Key insight
Formal relationship between monetary developments andmarket-based �nancing:
"monetary policy" (interest rates)
� limited commitment� not targeted
the more economic actors exhibit interest-rate vulnerability, the morethe central bank must keep interest rates low.
Private leverage choices strategic complements through reactionof monetary policy
6
![Page 7: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/7.jpg)
Key insight
Formal relationship between monetary developments andmarket-based �nancing:
"monetary policy" (interest rates)
� limited commitment� not targeted
the more economic actors exhibit interest-rate vulnerability, the morethe central bank must keep interest rates low.
Private leverage choices strategic complements through reactionof monetary policy
7
![Page 8: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/8.jpg)
Key insight
Formal relationship between monetary developments andmarket-based �nancing:
"monetary policy" (interest rates)
� limited commitment� not targeted
the more economic actors exhibit interest-rate vulnerability, the morethe central bank must keep interest rates low.
Private leverage choices strategic complements through reactionof monetary policy
8
![Page 9: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/9.jpg)
Corollaries
Private leverage decisions highly sensitive to macroeconomicconditions.
Private sector interest-rate vulnerability may increase when bad newsabout future liquidity needs accrue.
Monetary policy time-inconsistent, not for standard in�ation-biasreason.
Need for macro-prudential supervision.
9
![Page 10: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/10.jpg)
II. DESCRIPTION OF MODEL
Choice of exposure to liquidity risk = choice between twotechnologies: "risky" and "safe". In practice:
reliance on securitization.
lack of hedging (purchase of protection),
failure to hoard assets or secure lines of credit.
Risky technology allows larger investment.
10
![Page 11: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/11.jpg)
II. DESCRIPTION OF MODEL
Choice of exposure to liquidity risk = choice between twotechnologies: "risky" and "safe". In practice:
reliance on securitization.
lack of hedging (purchase of protection),
failure to hoard assets or secure lines of credit.
Risky technology allows larger investment.
11
![Page 12: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/12.jpg)
II. DESCRIPTION OF MODEL
Choice of exposure to liquidity risk = choice between twotechnologies: "risky" and "safe". In practice:
reliance on securitization.
lack of hedging (purchase of protection),
failure to hoard assets or secure lines of credit.
Risky technology allows larger investment.
12
![Page 13: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/13.jpg)
CENTRAL BANK
Objective function
Can distort consumers�marginal rate of substitution between dates 1and 2, and lower (one plus) rate of interest R < R�. Distortion cost(MRS 6=MRT): L( R
(�)) = loss
13
![Page 14: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/14.jpg)
CENTRAL BANK
Objective function
Can distort consumers�marginal rate of substitution between dates 1and 2, and lower (one plus) rate of interest R < R�. Distortion cost(MRS 6=MRT): L( R
(�)) = loss
14
![Page 15: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/15.jpg)
MONETARY BAILOUTS
If �rm
has no cash at date 1 (extreme case: no store of value between dates0 and 1)
faces liquidity need,
then it must issue new securities on date-2 cash �ow.
Re�nancing constraint:
pledgeable incomeR
� reinvestment need (*)
Lower interest rate facilitates re�nancing. Let R0 < R� satisfy (*)with equality.
15
![Page 16: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/16.jpg)
MONETARY BAILOUTS
If �rm
has no cash at date 1 (extreme case: no store of value between dates0 and 1)
faces liquidity need,
then it must issue new securities on date-2 cash �ow.
Re�nancing constraint:
pledgeable incomeR
� reinvestment need (*)
Lower interest rate facilitates re�nancing. Let R0 < R� satisfy (*)with equality.
16
![Page 17: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/17.jpg)
∆ � β [bene�t for �rm from being able to continue]
�[reinvestment need� pledgeable incomeR �
]
X Bene�t of low interest rate policy is proportional to number of �rmsthat have chosen risky technology and are in distress:
X Cost of low interest rate policy L(R0) is �xed (independent of x)
Non-targeted policy
17
![Page 18: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/18.jpg)
∆ � β [bene�t for �rm from being able to continue]
�[reinvestment need� pledgeable incomeR �
]
X Bene�t of low interest rate policy is proportional to number of �rmsthat have chosen risky technology and are in distress:
X Cost of low interest rate policy L(R0) is �xed (independent of x)
Non-targeted policy
18
![Page 19: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/19.jpg)
∆ � β [bene�t for �rm from being able to continue]
�[reinvestment need� pledgeable incomeR �
]
X Bene�t of low interest rate policy is proportional to number of �rmsthat have chosen risky technology and are in distress:
X Cost of low interest rate policy L(R0) is �xed (independent of x)
Non-targeted policy
19
![Page 20: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/20.jpg)
Result #1. If ∆γx � L(R0)monetary bailout.
Strategic complementarities
Result #2. Time inconsistency(di¤erent from standard TI, à la Kydland-Prescott).
Result #3 Monetary bailout
Risky corporate behavior more likely if
higher weight of corporate sector in central bank�s objective (β high)
liquidity shocks more likely (γ high) ! contrast with commitmentsolution.
20
![Page 21: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/21.jpg)
Result #1. If ∆γx � L(R0)monetary bailout.
Strategic complementarities
Result #2. Time inconsistency(di¤erent from standard TI, à la Kydland-Prescott).
Result #3 Monetary bailout
Risky corporate behavior more likely if
higher weight of corporate sector in central bank�s objective (β high)
liquidity shocks more likely (γ high) ! contrast with commitmentsolution.
21
![Page 22: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/22.jpg)
Result #1. If ∆γx � L(R0)monetary bailout.
Strategic complementarities
Result #2. Time inconsistency(di¤erent from standard TI, à la Kydland-Prescott).
Result #3 Monetary bailout
Risky corporate behavior more likely if
higher weight of corporate sector in central bank�s objective (β high)
liquidity shocks more likely (γ high) ! contrast with commitmentsolution.
22
![Page 23: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/23.jpg)
Regulating leverage
X With commitment, no need for leverage regulation:
� privately and socially sub-optimal to start a risky project that is dis-continued in case of distress
� privately and socially optimal to choose risky project if monetary bailout
X Without commitment, leverage regulation to alleviate temptation tobail out.
Macro-prudential regulation
23
![Page 24: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/24.jpg)
Regulating leverage
X With commitment, no need for leverage regulation:
� privately and socially sub-optimal to start a risky project that is dis-continued in case of distress
� privately and socially optimal to choose risky project if monetary bailout
X Without commitment, leverage regulation to alleviate temptation tobail out.
Macro-prudential regulation
24
![Page 25: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/25.jpg)
FISCAL BAILOUTS
X Di¤erent kind of ine¢ ciency. Can be targeted. But (due toinformational limitations) consumer money may end up subsidizing�rms that don�t need it.
X Monetary and �scal bailouts. May be complements.
25
![Page 26: Future of Financial Regulation - Banque de France · The Future of Financial Regulation. Banque de France - TSE conference . January 28, 2009. ... about future liquidity needs accrue.](https://reader033.fdocuments.net/reader033/viewer/2022053004/5f0803fa7e708231d41fe7e1/html5/thumbnails/26.jpg)
FISCAL BAILOUTS
X Di¤erent kind of ine¢ ciency. Can be targeted. But (due toinformational limitations) consumer money may end up subsidizing�rms that don�t need it.
X Monetary and �scal bailouts. May be complements.
26