Understanding Systemic Risk in Global Financial Markets

Preface xiii
Acknowledgments xvii
About the Authors xviii

CHAPTER 1
Introduction to Systemic Risk
What Is Systemic Risk?
Systemic Risk Driver
Why Systemic Risk Must Be Understood, Monitored, and Manage

CHAPTER 2
How We Got Here: A History of Financial Crises
Common Drivers of Historical Crises
Bursting of Asset Bubbles
Banking Crises
Sovereign Debt Crisis
International Contagion

CHAPTER 3
The Credit Crisis of 2007–2009
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

CHAPTER 4
Systemic Risk, Economic and Behavioral Theories: What Can We Learn?
Minsky Three-Part Model
Debt Deflation Cycle
Benign Neglect
Behavioral Theories
Risk Aversion Bias
Asset Prices
Homogeneous Expectations versus Heterogeneity
Anchoring Heuristic
Excessive Optimism
Familiarity Bias
Fallacy of Composition
Fight or Flight

CHAPTER 5
Systemic Risk Data
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

CHAPTER 6
Macroprudential versus Microprudential Oversight
A Comparison of Macroprudential versus Microprudential
Microprudential Policies
Macroprudential Policies
A Historical Perspective on Macroprudential Tools
Choice of Macroprudential Policy Tools

CHAPTER 7
Introduction to the U.S. Regulatory Regime
Who Are the Regulators?
U.S. Regulatory Approaches
Comparison of U.S. versus International Financial Regulatory Regimes
Introduction to the Dodd-Frank Act

CHAPTER 8
Introduction to International Regulatory Regimes
The Financial Stability Board
The Basel Accords
The European Systemic Risk Board
Principles for Financial Market Infrastructures

CHAPTER 9
Systemically Important Entities
Introduction to Systemically Important Entities
Classification of Entities as Systemically Important by the FSOC
Bank SIFIs
Nonbank SIFIs
SIFMUs
Globally Systemically Important Banks
Total Loss-Absorbing Capacity (TLAC) Requirements
Broad Impact of Financial Stability Requirements

CHAPTER 10
The Volcker Rule
Introduction to the Volcker Rule
The Volcker Rule: Details
Prohibition of Proprietary Trading
Prohibition of Ownership or Sponsorship of Hedge Funds and Private Equity Funds
The Volcker Rule and Systemically Risky Nonbank Financial Companies
Activities That Are Permitted Despite the Volcker Rule
Implementation of the Volcker Rule
Volcker Rule: Criticism

CHAPTER 11
Counterparty Credit Risk
Overview of Derivative Securities
Counterparty Exposure
How Counterparty Credit Risk Is Managed
Collateral
Netting
Central Counterparties
Counterparty Credit Risk and Systemic Risk

CHAPTER 12
The Dodd-Frank Act and Counterparty Credit Risk
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
Mandatory Clearing
Execution Platforms and Data Repositories
Registration Requirements
The Push-Out Rule
The End User Exemption
Criticism of Title VII of the Dodd-Frank Act

CHAPTER 13
The Basel Accords
What Are the Basel Accords?
The Approach of the Basel Accords
Basel I
Basel II
Pillar 1: Minimum Capital Requirements
Pillar 2: Supervisory Review
Pillar 3: Market Discipline
Basel II.5
Basel III
The Continuing Evolution of the Basel Accords

CHAPTER 14
Lender of Last Resort
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

CHAPTER 15
Interconnectedness Risk
A Case Study of Interconnectedness
Interconnectedness Categories
The Depository Trust & Clearing Corporation
Post-Crisis Regulatory View of Interconnectedness
Basel Committee on Banking Supervision
Office of Financial Research
CPMI IOSCO Principles
An Approach to Analyzing Interconnectedness Risk
The Depository Trust & Clearing Corporation

CHAPTER 16
Conclusion: Looking Ahead
It’s Not a Question of If, but When, Where, and How
A Summary of Global Surveys
Sources of Systemic Risk
Preparing for the Next Crisis
Appendix: Systemic Risk Models
Structural versus Reduced-Form Credit Models
Contingent Claims and Default Models
Merton versus Garch
Studies in Support of Merton
Macroeconomic Measures
Probability Distribution Measures
Illiquidity Measures
Counterparty Risk Measures
Behavioral Models
Solutions to the Knowledge Check Questions
Index