Crisis Economics: A Crash Course in the Future of Finance

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For example, the Securities and Exchange Commission SEC could require anyone issuing asset-backed securities to disclose a range of standard information on everything from the assets or original loans to the amounts paid to the individuals or institutions that originated the security. Precisely how this information is standardized doesn't matter, so long as it is done: At the present time, we are stymied by a serious apples-and-oranges problem: Put differently, the current system gives us no way to quantify risk; there's far too much uncertainty.

Standardization, once achieved, would inevitably create more liquid and transparent markets for these securities. That's well and good, but a few caveats also come to mind. First, bringing some transparency to plain-vanilla asset-backed securities is relatively easy; it's more difficult to do so with preposterously complicated securities like Collateralized Debt Obligations CDOs , much less chimerical creations like the CDO2 and the CDO3.

Think for a moment about what goes into a typical CDO. Start with a thousand different individual loans, be they commercial mortgages, residential mortgages, auto loans, credit card receivables, small business loans, student loans, or corporate loans. Package them together into an asset-backed security ABS. Is that going to happen?

For that reason, securities like CDOs -- which now go by the nickname of Chernobyl Death Obligations -- must be heavily regulated if not banned. In their present incarnation, they are too estranged from the assets that give them value and are next to impossible to standardize. Thanks in large part to their individual complexity, they don't transfer risk so much as mask it under the cover of esoteric and ultimately misleading risk-management strategies.

In fact, the curious career of CDOs and other toxic securities brings to mind another, less celebrated acronym: GIGO, or "garbage in, garbage out". Or to use a sausage-making metaphor: The most important angle of securitization reform, then, is the quality of the ingredients.

In the end, the problem with securitization is less that the ingredients were sliced and diced beyond recognition than that much of what went into these securities was never very good in the first place. Put differently, the problem with originate-and-distribute lies less with the distribution than with the origination. What matters most is the creditworthiness of the loans issued in the first place.

Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis. So-called over-the-counter derivatives -- better described as under-the-table -- must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted.

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Moreover, the regulation of derivatives should be consolidated under a single regulator. The ratings agencies must also be collared and forced to change their business model. That they now derive their revenue from the firms they rate has created a massive conflict of interests. Investors should be paying for ratings on debt, not the institutions that issue the debt. Nor should the rating agencies be permitted to sell "consulting" services on the side to issuers of debt; that creates another conflict of interests.

Finally, the business of rating debt should be thrown open to far more competition. At the present time, a handful of firms have far too much power.

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Even more radical reforms must be implemented as well. Certain institutions considered too big to fail must be broken up, including Goldman Sachs and Citigroup. But many other, less visible, firms deserve to be dismantled as well.

Crisis Economics. A Crash Course in the Future of Finance

Moreover, Congress should resurrect the Glass-Steagall banking legislation that it repealed a decade ago but also go further, updating it to reflect the far greater challenges posed not only by banks but by the shadow banking system. These reforms are sensible, but even the most carefully conceived regulations can go awry. Financial firms habitually engage in arbitrage, moving their operations from a well-regulated domain to one outside government purview.

The fragmented, decentralized state of regulation in the United States has exacerbated this problem. So has the fact that the profession of financial regulator has, until very recently, been considered a dead-end, poorly-paid job. Most of these problems can be addressed. Regulations can be carefully crafted with an eye toward the future, closing loopholes before they open.

That means resisting the understandable impulse to apply regulations only to a select class of firms -- the too-big-too-fail institutions, for example -- and instead imposing them across the board, in order to prevent financial intermediation from moving to smaller, less-regulated firms. Likewise, regulation can and should be consolidated in the hands of fewer, more powerful regulators. And most important of all, regulators can be compensated in a manner befitting the key role they play in safeguarding our financial security.

Central banks arguably have the most power -- and the most responsibility -- to protect the financial system.

Crisis Economics: A Crash Course in the Future of Finance

In recent years, they have performed poorly. They have failed to enforce their own regulation, and worse, they have done nothing to prevent speculative manias from spinning out of control. Roubini and Mihm are a great pair. A few specific things you will learn from this book: How shadow banks effectively function like banks, creating leverage and debt, with the risks that entails even though they escape the regulation that pertains to banks. How the financial system creates the structures which result in the chain of events that cause a crisis and that freeze lending and liquidity.

Why transactions and trades done in a non-transparent way cause a panic.

Crisis Economics: A Crash Course In The Future Of Finance By Nouriel Roubini

How leverage leads to crashes in the values of a range of assets. Something about the huge changes in the structure of the financial system and how very large institutions banks, investment banks, and shadow banks have been swallowed up or have disappeared entirely. How securitization, for example of home loans, leads to problems when those who create the securities have an incentive to create those securities and do not fully shoulder the risks of those securities perhaps because they can sell them to others in the securitization food chain.

How bank regulation and bank capitalization requirements, or more importantly, their failure, led us to the current crisis. An account of how the financial system collapsed, step by step. Importantly, how the crisis was a collapse of the shadow banks, i. How the crisis spread across the world. Nouriel Roubini , Stephen Mihm. This myth shattering book reveals the methods Nouriel Roubini used to foretell the current crisis before other economists saw it coming and shows how those methods can help us make sense of the present and prepare for the future.

The Causes and Effects of the Financial Crisis 2008

Renowned economist Nouriel Roubini electrified his profession and the larger financial community by predicting the current crisis well in advance of anyone else. Armed with an unconventional blend of historical analysis and global economics, Roubini has forced politicians, policy makers, investors, and market watchers to face a long-neglected truth: Drawing on the parallels from many countries and centuries, Nouriel Roubini and Stephen Mihm, a professor of economic history and a New York Times Magazine writer, show that financial cataclysms are as old and as ubiquitous as capitalism itself.

The last two decades alone have witnessed comparable crises in countries as diverse as Mexico, Thailand, Brazil, Pakistan, and Argentina. All of these crises-not to mention the more sweeping cataclysms such as the Great Depression-have much in common with the current downturn.

Bringing lessons of earlier episodes to bear on our present predicament, Roubini and Mihm show how we can recognize and grapple with the inherent instability of the global financial system, understand its pressure points, learn from previous episodes of "irrational exuberance," pinpoint the course of global contagion, and plan for our immediate future. Perhaps most important, the authors-considering theories, statistics, and mathematical models with the skepticism that recent history warrants—explain how the world's economy can get out of the mess we're in, and stay out.

In Roubini's shadow, economists and investors are increasingly realizing that they can no longer afford to consider crises the black swans of financial history. A vital and timeless book, Crisis Economics proves calamities to be not only predictable but also preventable and, with the right medicine, curable.

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