1 10 Research and Policy 3 CFS Financial Center Index / 14 CFS Strategy 2010 3 Events 16 CFS Program of Research Visitors 4 CFS Colloquium 16 CFS Data Center 4 CFS Lectures 22 CFS-GSEFM Policy Research Network 5 Joint Lunchtime Seminars 24 Policy Platform 7 CFS Conferences 27 CFS Publications 11 News from CFS 29 The Macroeconomic Model Data Base 12 Supporters 32
Editorial
The Meaning of Crisis in Greek Causes of the Crisis and Crisis Management
While trying to recover from a financial crisis, Europe is hit by a major sovereign debt crisis, whose main causes are to be traced to structural problems, especially in the South. While contributing to the crisis, speculation in credit swap markets and government bond spreads were not its root causes. Drastic revisions in Greek deficit forecasts following the Greek elections late last year, coupled with a tainted reputa- tion for misreporting economic statistics, served to focus attention on Greece’s fiscal fundamentals, including the country’s ability to collect tax revenues – the very aspect that guarantees sovereign debt. This ability was doubted, because of massive tax evasion and considerable corruption in the tax collection mechanism; and because of low productivity and heavy reliance of the private sector on public sector projects and funds.
Ironically, both the German and the Greek
Source: Wikimedia Commons, Roccuz, Relief of the Mourning Athena, 460 B.C..jpg, Free Cultural Work governments were blamed for delayed ➾
Gesellschaft für Kapitalmarktforschung e.V.: Chairman Board of Trustees: Prof. Dr. Dr. h.c. mult. Otmar Issing; Chairman Managing Board: Dr. Rolf-E. Breuer Center for Financial Studies: President: Prof. Dr. Dr. h.c. mult. Otmar Issing; Directors: Prof. Michael Haliassos, Ph.D., Prof. Dr. Jan P. Krahnen, Prof. Dr. Uwe Walz. Editorial | The Meaning of Crisis in Greek reaction to the crisis, that significantly More is needed – Now the competitive economic game should be aggravated the crisis. Politically, this criti- simplified and harmonized, with emphasis cism does not seem justified: German tax- Emergency debt refinancing measures on providing equal opportunities, sound payers were particularly averse to dishing need to be combined with changes that incentives, and rewards for productive out funds for a country characterized by ensure longer-run fiscal viability and ability effort rather than political favors. Labor excessive spending, limited tax and pension to generate tax revenues, in order to meet market rigidities should be abolished, contributions, antiquated and generous debt obligations and achieve debt retire- including ‘closed professions’ and groups labor market and retirement rules. Greek ment. The alternative of a transfer union with preferential treatment based on voters, on the other hand, would not seems politically unworkable and economi- political power, in order to allow access have accepted the current harsh measures cally very costly, given the transfer union’s to outsiders and to improve flexibility and immediately following Greek elections detrimental effects on fiscal discipline and hence productivity in European economies. where unnecessarily huge pre-election reduced incentives of net payers. This is Clear incentives to invest financial and promises were made. especially so if transfers are not used to human capital in the private sector should smooth temporary imbalances in either be provided and bureaucratic procedures Economically, perhaps the unusually high direction. The other alternative, namely (e.g., for setting up a business) should be spreads in early May could have been default on sovereign debt, carries with it a drastically simplified. The pension system avoided through earlier concerted Euro- heavy stigma that could cut off European needs to be modernized and rationalized, pean action. Yet, at the time of writing, and countries (not only Greece) from impor- reducing implicit public debt (which is far despite available funds and apparent ECB tant sources of future financing and would larger than the official debt figures in many purchases of Greek bonds, spreads remain most likely also lead to the break-up of the European countries), an urgent task in quite high, reflecting market uncertainty Eurozone, the scenario the current crisis rapidly aging European societies. as to whether Greece will be able to management wanted to avoid. The stigma is repay loans even at a 5% interest rate. If especially pronounced when default cannot A big danger is that these structural the market is right, the current spreads be attributed to exogenous factors, such as reforms are seen as needed only ‘over the are induced by fundamentals and not by a world financial crisis, but to bad domestic longer run’. Contrary to Keynes’ famous inaction. The criticism could be valid, institutions and practices. dictum, Europe actually needs to make though, if the market’s current assessment sure it survives in the long run, and this is of sovereign risk is partly due to the erratic Massive reforms are needed to ensure a process that starts today. Europe needs to behavior of governments as they were future increases in productivity, growth, act not only as a tough lender but also as groping for an agreement. and competitiveness, so that European a coordination device that helps countries countries can generate the funds to meet to move towards sound fiscal behavior. If Timing issues aside, there is little doubt that future obligations, reduce debt levels, and all that happens today is the misery of tax the safety net and associated ECB purchases offer their people hope for the future. collection and wage reduction, a number of of sovereign bonds were unavoidable, given Without such reforms, the current cuts countries can be drawn into a deflationary the risk of contagion to other European in fiscal expenditures and nominal wages, spiral; and countries such as Greece may countries with similar but less pronounced as well as the increases in consumption exhibit a form of hysteresis, whereby they structural debt problems, and the threat taxes simply reduce disposable income, lose some of their most productive people to stability of the currency union. Indeed, raise unemployment, and create a deep and dynamic and internationally competi- buying government debt does not mean per recession with massive costs that jeopardize tive firms. In a crisis, such losses occur fairly se that the ECB has lost its independence. social cohesion. quickly as people re-optimize, but they are Independence is questioned if the ECB is difficult to reverse. In sum, Europe as a forced to accept higher inflation in viola- At the core is fiscal coordination that does whole needs to use this crisis in a way tion of its stated targets – a development it not prevent fiscal competition. Rules for consistent with the many positive meanings currently rules out. However, much more setting limits on government spending and of the word in the ancient Greek language is needed to ensure that debt gets repaid for designing methods of tax collection where it originated: test, judgment, choice, and such problems do not recur. should be harmonized with reference to competition, and resolution. best practices. Restraints on fiscal deficit and debt levels need to be monitored very Michael Haliassos and Uwe Walz closely and in a timely fashion. The rules of
CFS Strategy 2010| Research and Policy
CFS Strategy 2010
CFS-GSEFM New Program Research Policy Program Network Visitors Data Research Networks Support Program Center Network
CFS is in the process of redefining its Besides running lecture series, workshops CFS will also contribute considerably role within the House of Finance. More and conferences, CFS will extend its role to facilitating research by providing emphasis is being put on the cooperation in inducing and generating high-quality “logistic” support for the research with the different entities – institutes and research with an eye on policy relevance activities in the areas and their networks. departments – in the House. The aim is in key areas of financial and monetary With the Program Network Support to eventually create synergy effects for economics. Several initiatives will help initiative, CFS will assist in the submission all parties involved, thus contributing not to provide additional effective stimuli for process for research grants by writing only to research excellence, but also to research and dialogue. and subsequent monitoring of research research relevance. proposals. This central contact point will Our research facilities will be enhanced by work closely with the research networks CFS’ role remains anchored in its mission a CFS Research Visitors Program and and will look at the opportunities for statement, stressing its role as an inde- a CFS Data Center (more information network building and support. pendent research institution with a strong can be found on page 4). In addition to international orientation. CFS builds on that, the existing research programs will Not to forget, CFS is a co-founder of its experience as a forum for dialogue get a “remake”, with fewer research areas and an active participant in the recently between academia, policy-making institu- and stronger emphasis on cooperation established House of Finance Policy tions and the financial community. CFS’ among researchers and across disciplines. Platform, jointly run by researchers role is being recognized and valued in- The idea is that a network (both from the House of Finance with a strong and outside the academic community, in internationally and locally) of research experience in policy advisory. CFS’ role Germany and abroad. fellows and affiliates is built around each in fostering policy relevance is assisted research area. The networks, each headed by another new initiative which links Since its foundation, CFS has been by a Research Professor, will apply for its activities to the University’s Ph.D. active as an important bridge, not only projects and funding and will set up their programs in Economics, Finance and between the finance and money group research program. The five research Law. at the University, but also between the networks currently envisaged are: academic world and the main private and This is the planned CFS-GSEFM governmental institutions around us. CFS 1. Household Finance Policy Research Network, which has several long-standing cooperation 2. Financial Stability and Banking will develop a direct linkage between projects, e.g. with central banks, private Regulation policy debate and academic research. and public sector banks, and key finan- 3. Law & Economics of Financial cial sector institutions. CFS will further Organizations develop its network within academia and 4. Monetary Policy the financial industry in Europe. 5. Economics of Trading in Financial Markets
Research and Policy | CFS Strategy 2010
The New CFS Program of Research Visitors
As part of its new strategy, CFS financial community. The choice will depend on the field of is launching a new program of the visitor and its likely appeal to the research and practitioner Research Visitors, at two levels: community. Finally, visitors agree to be available for discussions Senior and Junior. In both cases, the on research with CFS fellows, Senior and Junior, as well as program is intended to provide an with interested faculty at Goethe University. The visits will be opportunity for useful exchanges typically funded through external funds, and such funding will and transfer of knowledge that be explicitly recognized when advertising the research visit. promote research within CFS research networks but also among Junior Visitors graduate students and Goethe by Michael Haliassos faculty at large. Junior visitors will typically be young researchers who have finished their Ph.D. and are currently doing interesting Senior Visitors research in one of the CFS research networks. They will be visiting typically for periods of 6 months to 2 years, and their Senior visitors will be invited to spend a short period at CFS, main obligation will be to work on their research papers usually two weeks. During this period, they will be asked to give and to provide positive externalities (but not regular formal a graduate minicourse, intended to communicate to graduate teaching) to students and faculty at Goethe University. The students and faculty the latest research tools, methods, and latter may include contributions to our Data Center (e.g., in results in the area of the research visitor. Typically, the material the form of data or programs), a few lectures on new issues will be drawn from the latest papers in the current research or techniques with which they are familiar, collaboration in field of the visitor. The minicourses will be open to students the organization of research conferences or seminar series, and faculty of CFS, any CFS fellows in residence at the time and other related activities. Junior visitors will be paid at rates of the visit, and possibly to individuals from selected Frankfurt comparable to those of researchers at Goethe University. In institutions with which CFS has reciprocal arrangements for addition to external funds made available to it by its sponsors, access to data or to researchers. In addition, senior visitors it is envisaged that CFS will apply, in due course, to funding will be asked to give either one research seminar at Goethe agencies, such as the European Union Marie Curie program for University or a CFS public lecture to the broader Frankfurt postdoctoral fellows.
The New CFS Data Center
The creation of the CFS Data The CFS Data Center will host data from three different Center is one of the main pillars sources: commercial data sets; data sets that are publicly of the new CFS strategy to foster available free of charge; and proprietary data sets. the production of research in the area of financial and monetary Commercial Data Sets economics. Access to high-quality data sets is a necessary condition Based on the expertise and the underlying demand in the new for top quality research in many research networks, we aim to provide commercial data sets that parts of these two fields. Thus, the are in high demand in the main areas of research at CFS. These CFS Data Center is likely to be a data sets are intended to complement the existing data sources valuable resource for the entire already provided under the data pool sponsored by the House by Uwe Walz CFS community, including not only of Finance and the Department of Business Administration CFS researchers, but also their visitors and fellows based outside and Economics at Goethe University. CFS will thus offer a the CFS. It is envisaged that this data center will complement complementary source of research information that links itself other initiatives being pursued under the new strategy. with other entities at the House of Finance and beyond.
CFS Strategy 2010 | Research and Policy
Publicly available Data Sets however, are clearly underused (e.g. due to fact that people move on to other research areas or focus on only certain In a number of fields, data sets are freely available to the aspects of a data set). This would include, for example, data public. Often, they require some polishing and/or interfaces on share prices and listed German companies for the period in order to make their application much less demanding and 1880 to 1950. The main contribution of the CFS Data Center less time-consuming. Thus, the polishing of data sets and the here will be to polish these data sets and to make them more setting up of (web-based) interfaces will be at the core of the accessible by providing proper interfaces and data descriptions activities of the staff of the CFS Data Center. A future way of and other necessary documentation. producing valuable data sources from publicly available data will be to merge respective data sets (e.g. across countries) in Altogether, the CFS Data Center will not just be a provider of a consistent manner. data sets, but rather a comprehensive service center; one which ensures that data access is more user friendly and, therefore, Proprietary Data Sets more attractive.
In a significant number of cases, valuable proprietary data sets have been set up by members of the CFS community which,
The CFS-GSEFM Policy Research Network
The inaugural “Global Economic and Financial Policy Series” to realize the three universities’ joint vision to establish a lecture by Citigroup Chief Executive Officer Vikram Pandit in premier European center for quantitative and research-oriented October 2009 was the first event organized jointly by CFS and graduate-level education in economics, finance and management. the Graduate School of Economics, Finance, and Management Leveraging the achievements of Goethe University’s established (GSEFM). Through his speech, Pandit triggered a lively discussion and highly successful Ph.D. Program in Economics, GSEFM’s with GSEFM graduate students on issues of financial innovation, overarching objective is to produce outstanding economists financial regulation and the future of banking. The event was capable of taking leading positions in academia or serving as highly successful (see also Newsletter 2/09) and has inspired experts in international institutions, government and the private CFS and GSEFM to widen their cooperation. As part of this sector (see also www.gsefm.eu). widened cooperation, CFS and GSEFM have agreed to launch the new “Policy Research Network”, aimed at stimulating The CFS-GSEFM Policy Research research on key aspects of economic and financial policy. The Network will involve summer new CFS-GSEFM Policy Research Network will link to the institutes and other forms of “Policy Platform” already established at the House of Finance structured interaction between (HoF), providing the doctoral students at GSEFM with various GSEFM doctoral students, GSEFM forms of structured interaction with internationally recognized faculty members, the heads of the senior researchers and policy makers. CFS research areas and policy makers. While the papers written The HoF Policy Platform − founded in 2009 by CFS, the within the Policy Research Net- Institute for Financial and Monetary Stability as well as the work will likely have significant Michael Binder Institute for Law and Finance − is currently operating a impact well beyond the confines of website featuring policy commentaries and OpEds written academia, in line with the focus of GSEFM, the Policy Research by academics from within the HoF, the Faculty of Economics and Network will give strong weight to placement of the papers in Business Administration, as well as the Faculty of Law at Goethe refereed journals. Michael Binder, who is Founding Dean of University (see also page 7). GSEFM and has had a long-standing affiliation with CFS, will head the CFS-GSEFM Policy Research Network. His close GSEFM − founded in 2008 − constitutes an alliance between interaction with GSEFM’s doctoral students and his thorough Goethe University Frankfurt, Johannes Gutenberg University understanding of the CFS network make him an excellent Mainz and Technical University Darmstadt. GSEFM aims choice for directing this highly promising new initiative.
Research and Policy | CFS Strategy 2010
Encouraging Research on Banking Regulation and Banking Supervision
A first event already took place this During the workshop, Düllmann and his team outlined a spring, when Dr. Klaus Düllmann number of “hot” topics for policy research. He presented from the Deutsche Bundesbank spoke several ongoing regulation initiatives, and outlined for each to advanced Ph.D. students and faculty initiative a number of related research topics. The research members about possible research subjects he presented covered a range of issues, including initiatives in the field of banking regu- macro-prudential regulation, liquidity regulation, securitization lation and supervision. The workshop and the originate-to-distribute (OTD) model, crisis solution was meant to initiate collaboration and intervention, as well as improvements to stress tests. between the Research Centre at the Klaus Düllmann Bundesbank and young researchers Having outlined the various research topics, students were at the university. The idea is to give students the possibility to invited to speak with Bundesbank staff members present at participate in research projects on topics related to banking the workshop about the possibility of collaborating on specific regulation and the recommendations of the Basel Committee research projects. on Banking Supervision.
CFS-LEMF Summer School
Our yearly summer school will also be adjusted to reflect the new strategy. Cooperation with other departments or Doctorate / Ph.D. Program LAW AND ECONOMICS OF university entities has now been brought to the forefront and MONEY AND FINANCE the overall emphasis has shifted towards course offerings for Ph.D. students and PostDocs. This year’s Summer School will Legal Topics be held from 16 till 20 August 2010, and is a joint project 1. with the Doctorate/Ph.D. Program on Law and Economics of x Offer and acceptance x Consideration Money and Finance. x Damages for breach x Contract interpretation x Warranties and allocation of risk A brochure can be downloaded from the internet: http://www.hof.uni-frankfurt.de/lemf/images/ brochure_summer school 2010.pdf 2.Economic Theory
x of contract default and mandatory rules Summer School 2010 x of damage; i.e., the incentives created for breach and investment The 2010 Summer School will focus on the legal and economic decisions by the various available damage remedies Law and Economics of Contracts x behind the doctrines of impracticability, impossibility, and aspects of contracts. The guest speakers will be Scott Baker frustration of purpose (Professor of Law at Washington University, St. Louis) and 16August – 20August 2010 x underlying forward and future contracts Douglas Cumming (Associate Professor in Finance and Entre- preneurship at the Schulich School of Business, York University, Financial Contracting Canada). 3. x The legal and economic aspect of contracts: an overview Analytical methods in law – an application to contract law A broad range of subjects will be covered. The program has been x x Contract law case studies and analysis divided into three main areas: 1) Legal Topics; 2) Economic x Financial contracting: overview and recent advances 1 Theory; and 3) Financial Contracting. Students will consider, for example, how to analyze and interpret contracts, as well as the economics behind contracts and contract analysis.
GUEST LECTURERS
Scott Baker Professor of Law, Washington University, St. Louis, USA
Scott A. Baker is a prolific and widely-respected law and economics scholar. His research tackles a wide range of topics, from judicial performance to the structure of law firms to problems in patent law.
Before joining the Washington University Law faculty in 2009, Baker was a professor of law at the University of North Carolina since 2002, where he taught Law & Economics, Corporate Finance, Contracts, Torts, Property, and Intellectual Property. He served as UNC’s associate dean for faculty affairs from July to The lectures will take place from morning 16 August, 2010 until evening of 20 August, 2010. December 2007 and received the McCall Award for Law School Teacher of the Year in 2005. He also held a courtesy appointment as professor of economics at UNC. The total fee is 400 € and covers lunch as well as reading materials. His research interests lie at the intersection of law, economics, and game theory. Tuition can be completely or partially waived for students. His co-authored work has appeared in the Journal of Law and Economics, the Journal of Law, Economics and Organization, and numerous other law reviews. He is the recipient of a Tilburg For further information please contact: University grant for studies in the law and economics of innovation.
Baker clerked for Judge E. Grady Jolly of the United States Court of Appeals for the Fifth Circuit. Claudia Bieber, LL.M. | Managing Director | Ph.D. Program in Law and Economics of Money and Finance (LEMF)
House of Finance | Goethe University Frankfurt | Grüneburgplatz 1 | D-60323 Frankfurt am Main
[email protected] | www.lemf.uni-frankfurt.de | Phone +49 (0)69 798-33778
Douglas Cumming Schulich School of Business, York City, Canada
Douglas Cumming holds the Ontario Research Chair in Economics and Cross Cultural Studies at the Schulich School of Business in Toronto. His research areas span topics that include law and finance, public policy, entrepreneurial finance, venture capital, private equity, IPOs, hedge funds, and exchange regulation and surveillance. He studies applied topics and makes use of a wide range of empirical methods. Douglas Cumming’s work often involves assessment of regulatory and other policy initiatives towards stimulating market activity.
Prior to joining the Schulich Business School he taught at Rensselaer Polytechnic Institute, 2005-2007 and from 2004-2005 was associate Professor of Finance at the University of New South Wales. He held visiting appointments inter alia at the University of Cambridge and the University of Amsterdam. Office Location Program Coordination
Goethe University Frankfurt Prof. Dr. Brigitte Haar More infos at Doctorate / Ph.D. Program Law and +49 (0)69 / 798-33764 Economics of Money and Finance www.hof.uni-frankfurt.de/lemf/ House of Finance | Grüneburgplatz 1 Prof. Dr. Uwe Walz 60323 Frankfurt am Main, Germany +49 (0)69 / 798-34821 Policy Platform | Research and Policy
House of Finance Policy Platform
Website: www.hof.uni-frankfurt.de/policy_platform
The Policy Platform website gives access to a pool of OpEds The objective is threefold, to make in-house generated policy- and working papers written by researchers from the House relevant research accessible to the general public, to support of Finance, or members of Goethe University’s Faculty of policy makers through ad-hoc advisory teams and policy briefs, Economics and Business Administration, and Faculty of Law. and to write policy-oriented White Papers on strategic aspects The contributions are published either as Policy Letter or as of finance and lawmaking. White Paper. White Papers comprise more comprehensive research-based contributions to current policy debates. Policy In the first half of 2010 the following articles were made Letters are short essays or commentaries on current policy available online: topics, usually written for publication in the press.
Policy Letters 2010 White Papers 2010
Mit Sparen stützt der Staat die Frühwarn- und Überwachungssystem zur Risiko und Risikosteuerung im Wirtschaft Stabilisierung der Finanzmärkte Aktienrecht Volker Wieland Stefan Gerlach Theodor Baums Handelsblatt – 8 June 2010 Neue Zürcher Zeitung – 16 April 2010 7 June 2010 Die Mär von der Spekulation Germany´s role in the Greek drama (letter Are the Golden Years of Central Banking Otmar Issing to the editor) Over? Monetary Policy after the Crisis FAZ – 27 May 2010 Stefan Gerlach Stefan Gerlach Financial Times – 12 April 2010 May 2010 Den Stabilitätspakt stärken: Staatsschulden besteuern Anheben des Inflationsziels wäre Systemische Risiken im Finanzsektor Stefan Gerlach verheerend – Lehren aus der Finanzkrise Börsen-Zeitung – 14 May 2010 Stefan Gerlach Roman Inderst Börsen-Zeitung – 1 April 2010 19 April 2010 Noch haben wir die Krise nicht gebannt Stefan Gerlach Höhere Löhne sind keine Lösung Consumer Protection in Markets Handelsblatt – 4 May 2010 Otmar Issing with Advice Financial Times Deutschland – 22 March 2010 Roman Inderst Wie arm oder reich ist Griechenland 16 April 2010 wirklich? Zur Stärkung der Deutschen Bundesbank Michael Haliassos Stefan Gerlach, Emilie Yoo Future Development of Global Handelsblatt – 7 May 2010 Ökonomenstimme – 22 March 2010 Imbalances Stefan Gerlach Warum werden die Banken immer Die Konsolidierung im Inneren muss 8 March 2010 verschont? Vorrang haben Jan Pieter Krahnen Helmut Siekmann Rettungsstrategie ohne Moral Hazard Handelsblatt – 7 May 2010 Börsen-Zeitung – 12 March 2010 – Versuch eines Gesamtkonzepts zur Bankkrisenvermeidung How to be a good European … Ein staatliches Hospital für kranke Banken Jan Pieter Krahnen, Helmut Siekmann Volker Wieland Jan Pieter Krahnen, Günter Franke 12 February 2010 www.oekonomenstimme.org – 4 May 2010 FAZ – 27 February 2010 Die Unabhängigkeit des G20 and Macro-prudential Policy Vergütungsberaters Stefan Gerlach Theodor Baums Bruegel | G20 Blog – 22 April 2010 January 2010
Research and Policy | Policy Platform
Rescue Strategy without Moral Hazard
This article summarizes the concept for crisis prevention and intervention, outlined in the White Paper by J. P. Krahnen and H. Siekmann “Rettungsstrategie ohne Moral Hazard – Versuch eines Gesamtkonzepts zur Bankkrisenvermeidung“. The paper was a draft for talks at the Federal Chancellery (Bundeskanzleramt) that took place in Berlin in February 2010. The complete German version can be downloaded from the Policy Platform website. A revised English version of the paper is scheduled to appear soon.
The financial crisis caught many unaware. Single Banks and constitute a legal obligation and are not Although a major collapse of the banking Crisis Prevention sufficiently covered by capital. The funding system could be prevented, the measures obligations are at least in the case of the taken at the time are now generally con- It can undoubtedly be said that the system deposit guarantee funds of the Association sidered to be unsuitable for the future. of banking supervision aimed at prevent- of German Banks (Bundesverband The main objection is the enormous ing a crisis within the financial system has deutscher Banken) too low. Furthermore, incentive for moral hazard, associated not fulfilled its intended purpose. This is reciprocal insurance can only work in the with state-financed rescue measures. true with respect to both the supervisory case of isolated banking problems. In any institutions as well as the recommenda- event an additional state deposit guarantee One of the most common insights gained tions of the Basel Committee. fund will be required and it might be in this crisis has been that systemic risks advisable to emulate the American Federal in the highly interlinked financial system The implications of systemic risk and Deposit Insurance Corporation that acts as represent a real threat. The danger of the eventuality of contagion between regulator and in the U.S. is perceived to be systemic risk and worldwide contagion banks have hitherto received little or no the most efficient supervisory institution. must be faced, without at the same time attention. An important issue is the pro- creating negative incentives “ex ante”. tection of individual institutions against Single Institutions and This suggests that a balanced set of a bank run, since it reduces the risk of Crisis Intervention instruments must be at hand with which contagion for other financial institutions banks may be rescued or wound down in and contributes to the stability of the Crisis prevention can only be successful an orderly fashion. system as a whole. when it is not counteracted by the In Germany there exists in this context expectations of market participants Making a distinction between acute a considerable need for reform. The about the behavior of regulators and and preventive rescue measures (crisis guarantee scheme for claims against central banks in the event of a crisis intervention and crisis prevention) is banks is divided according to the pillar (crisis intervention). The expectation has crucial. Furthermore, a distinction must structure of the German banking system. now arisen that, in an emergency, banks be made between the problems of an These claims are thus walled off from one will be unconditionally supported using individual bank and those of the financial another, which reduces the efficiency of taxpayers’ money and that creditors will system as a whole. Four cases or fields the system. Furthermore, the voluntary be safeguarded from any financial losses. for regulation arise from making this guarantee schemes that exceed the legally These expectations must now be credibly distinction: prescribed minimum insurance do not countermanded. A legally binding mechanism must be introduced by which shareholders and creditors participate in Crisis type/ strategy Crisis prevention Crisis intervention the burden of a bank collapse.
Single bank Equity/Basel II bank hospital (idiosyncratic) (+ESF) (+creditor liability) The existing insolvency proceedings have proved to be unsuitable. This deficiency Several banks Risk map, Systemic Risk bank hospital (systemic) Charge (+ESRB) (+CoCo) should be remedied by creating an institutionalized restructuring process for
Key: ESF = deposit guarantee funds · CoCo = contingent convertible bonds · ESRB = European Systemic Risk Board failing banks. A so-called “bank hospital”
Policy Platform | Research and Policy will be required, a state-run institution fatal results for other institutions. If a money. There are several arguments endowed with the power to enforce the systemic crisis threatens to become a in support of a reinvestment of the necessary procedures, even in the face simultaneous collapse of several important proceeds in the encumbered institutions of opposition from creditors and bank institutions, then there is no alternative to in the form of contingent convertible owners. In the event of a sudden crisis, coordinated state intervention. In this bonds (CoCo), namely bonds that upon the failing financial institution could be case it makes no difference whether the demand may be converted into equity. safeguarded from insolvency and then be cause is a run on the banks by depositors The conversion takes place when the restructured without haste. Parts of the or the mutual loss of confidence between financial institution is deemed to be business could be sold off or liquidated. the banks themselves. solvent but illiquid. Via the conversion Finally, the accounts could be settled In fact the accumulation of systemic risk the institution gains direct access to fresh and the remaining losses charged to the is generally not directly perceived by capital and is able to reduce its interest shareholders and creditors. In this way the the individual financial institution, nor payments, thus increasing its operating principle of privatizing profits and losses is it apparent in its balance sheet. The income and improving its liquidity could be enforced and the incentives for incurrence of systemic risk is in economic situation. When there is no crisis, such excessive risk-taking could be effectively terms an externality and it needs to be bond holdings are risk adequate and bear curtailed. internalized in order for it to appear in interest at the going market rate. The It would be appropriate not to focus on the operational costs and in the calculation decision for conversion should lie with the institution in its entirety but rather of return. In the first place a compulsory the supervisory authorities. on the individual contracts that the bank duty may be envisaged, which could be has entered. A financial institution’s in the form of a compensation charge. The Banking System and commitments could then be classified This type of charge is quite common Crisis Intervention: the Role as being either systemically relevant or in environmental policy aimed at of the Regulator systemically non-relevant. This evaluation minimizing negative (polluting) behavior of debt would be the task of the state that or at offsetting specific advantages or Combating a crisis of the entire banking underwrites the guarantees. In this way the disadvantages. The level of the charge system will again be a case for the bank systemically relevant parts of the company should be set according to the degree by hospital. The measures adopted will differ, can be safeguarded without eliminating which the asset in question contributes since the so called CoCo accumulated in the insolvency risk for the remainder. The to the overall systemic risk. This type times of no crisis can be completely or risk of default on non-systemic debt must of charge would ensure that systemic partially converted into equity. Following remain solely with the creditors. Through risks are made sufficiently “expensive” for the conversion the obligation to pay the appropriate regulations it must be individual institutions. interest is immediately dropped (liquidity ensured that all institutions at all times Nevertheless, determining the systemic effect) and equity capital is increased have sufficient non-systemic outstanding risks of individual banks or debts can give without having to resort to the capital liabilities at their disposal. In this way rise to considerable practical problems. market (solvency effect). an institution should be prevented from Almost no one saw in the top rated evading its immediate responsibilities by securities held by some banks the trigger For appropriate crisis prevention and claiming that all its debt is “systemic”. for a global crisis. In this context, we intervention, it is imperative to have a should remember the notion already well functioning supervisory authority. The Banking System and Crisis proposed by the German government at There are clear indications that the trend Prevention the G20 meetings of a risk map, capturing towards „self regulation“ in the financial the bilateral financial relationships sector in lieu of a strong supervision It is not always easy to differentiate between big, internationally active contributed significantly to the crisis. between the crisis of a single institution financial institutions. It is a prerequisite Measures and institutions aimed at and that of several institutions, or indeed for even being able to calculate the charges securing financial market stability serve of the system as a whole. The Lehman outlined above. society as a whole and should therefore bankruptcy showed that the linkage be largely financed by federal budget. The between financial institutions and their Assuming that it is indeed possible to regulatory laws set out in the Banking common dependency on the market levy such a charge, the question still Act and its implementing regulations evaluation of individual assets can have remains what should then happen to the require a thorough revision.
Research and Policy | Policy Platform
Too Much Money is Dangerous
“Inflation is always and everywhere a monetary phenomenon” is a well-known statement by Milton Friedman. Since the crisis, billions of cheap money are available in the market. Many articles recently titled “Keynes is back”. Indeed, a Keynesian spirit reigns around the globe. The Keynesian policy however implies huge public deficits and new financial bubbles. Does a renaissance of monetarism seem set?
The recent Keynesian renaissance is not surprising. The crisis that started in 2007 can only be compared in history with the vations, for example, were more or less multiplier effect is over-rated and that Great Depression after 1929. Keynes’ affecting the significance of monetary there is a changing attitude towards the General Theory of Employment, Interest, and aggregates and the control of the money huge government deficits. Money written in 1936 meant at that time supply was neglected or even ignored by a turning point towards an economic most central banks. Since the mid 90s, The widespread Keynesian belief that policy that tried to steer employment direct inflation targeting became the money doesn’t matter has proven to be from the demand side. This perception dominant strategy and academic discus- wrong. The inflation of asset prices was long present in Anglo-Saxon policy sions reflected these findings. worldwide would not have been possible but also in academic discussions. without the immense expansion of the Is monetarism dead? Although many money supply and the credit volume. The dominance of Keynesianism began recent developments might point in that to dwindle following two developments. direction, one should not ignore some of Monetarism will not return to its old The first was the theoretical and empiri- the key points of criticism that monetar- recipes. The models to explain monetary cal work mostly connected to Milton ism has brought forward. development will not rely on simple Friedman. The so-called monetarists money supply concepts. Credit volume challenged fundamental elements of the If central banks ignore the time lag in in all its facets will play a more central Keynesian theory and its application in the effect of monetary policy measures, role. The European Central Bank with economic policy. The second develop- which could be one to two years, there its two pillar strategy and its refined ment was a failure of the Keynesian is a danger that the inflationary dynamics monetary analysis will be well-armed to policy when government spending led are being underestimated. This in return face future challenges. Let’s only hope to high inflation without in the end could lead to a delayed exit from the that the world doesn’t have to endure a reducing unemployment. Monetarism expansionary policy. Is it possible that new phase of inflation in order to value offered an explanation for the failure of the high days of Keynesianism are already Milton Friedman’s words. the Keynesian policy and central banks over again? There is more and more started to integrate the new ideas in their evidence that the government spending policies. The Bundesbank, for example, was the first central bank to introduce a This article summarizes a contribution by Otmar Issing that was money supply target in 1975. published in Die Zeit on 5 March 2010 under the title “Zu viel Geld ist gefährlich”. The online version can be found on: Long before the outbreak of the current www.zeit.de/2010/10/F-Monetarismus. An article on this topic is also financial crisis, monetarism was already forthcoming in „The International Economy“ (Spring 2010 Edition). on the retreat. Numerous financial inno-
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Die Mär von der the euro down. According to Issing, this the current difficulties in Europe are not is a myth which tries to conceal the root just to be found in the budgetary problems Spekulation causes of the crisis by shifting the focus of Greece. All eurozone governments Otmar Issing, F.A.Z. – 27 May 2010 of attention to speculation – one that bear part of the responsibility, given the could cause some serious damage by previous tolerance of irresponsible fiscal In this article, Otmar Issing argues that opening the doors for the wrong policy behavior. the “Greek debacle” is a striking example responses. Proposals for reforming the Stability and of bending the truth, in that financial Is “speculation” really at play when pension Growth Pact, for improving the system speculation is blamed for the recent funds and investors turn their backs on of supervision and for sanctions are now developments in Europe. Speculation Greek government bonds in the face of on the table. Every effort should be made supposedly brought Greece to the brink Greece’s clearly failing national economic to find credible solutions, so that the of national bankruptcy, and then drove policy? Having said this, the reasons for mistakes of the past are not repeated.
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