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Short papers, policy comments, and speeches



The Internationalization of the Renminbi, November 2015


This talk was presented at the Guangdong University of Foreign Affairs and at Xinhua College of Sun-Yat Sen University during the first two weeks of November 2015.  In it I discuss the China’s proposal that the Renminbi be included in the basket of currencies that make up Special Drawing Rights of the International Monetary Fund.  I place this proposal in the context of China’s move toward a more open, market-based financial sector.  I argue that the push for SDR inclusion has served to speed up the process of financial liberalization by giving concrete objectives to the leaders of the Chinese state bodies and major financial enterprises that collectively decide the structure of the Chinese financial system. I review some of the steps that have been taken since 2009 and discuss the benefits that these can bring.  But financial liberalization carries with it very important challenges for China leaders in framing and communicating new policies that are appropriate for a new phase in China’s development which will be based on the growth of its internal market. A copy of this speech can be found here.  A few days following these talks the IMF made a press release announcing the IMF staff recommendation in support of the Renminbi’s accession to the SDR.


Doing the Right Thing: The Role of Banks in Society and the Economy, May 2015


This talk prepared for the BNP-Paribas European Bank Executive Committee Forum introduces a panel discussion on the theme of how banking cultural relates to the essential functions that serve in the economy and in society. I argue that trust is particularly important in banking because banks’ essential function involves a complex task of risk management, namely funding long-term risky and illiquid investment projects using shorter term, safer, more liquid financial contracts.   Without trust in banking there will be strong pressure for ever more invasive regulations. The result will be ham-strung banks that are unable to develop new products, to deal with complex problems, and generally to fulfil their essential functions in changing globalized economy. A copy of these remarks can be found here.


Systemic Risk: Creation and Perception, March 2014


In this talk prepared for the DTCC Risk Form in Brussels I argue that as compared to past financial crises that of 2007-2008 highlighted the critical role played by complexity, opacity and inadequate data analysis by market participants and regulators. Complexity likely to remain with us so long as the economy and financial system remain globalized while economic policy and financial regulation is in the hands of national authorities with very imperfect international coordination. To prepare for the systemic risks of the future and hopefully to manage them, we need to remember that risk (a probability distribution over a set of possible events) emerges from uncertainty through a process. This involves first the perception the relevant possible outcomes in a frame imposed by our imagined courses of action and second by the assessment of the relative likelihoods of these events through 'modelling' i.e., some combination of measurement, estimation and deductive reasoning. Systemic risk emerges endogenously in the economy through the interplay of economic actors. As new risks are perceived but not yet assessed there is a danger of a massive move toward prudence that provokes a crisis.  We have a collective interest in facilitating the process of learning about system wide risks in a continuous, decentralized way. In struggling to perceive and assess emerging systemic risk we should recall how risks build up through the process of intermediation involving credit transformation, maturity transformation and liquidity transformation.  Currently, the re-regulation of banking is reducing leverage, increasing liquidity on the asset side and reducing maturity mismatch in regulated banks.  This is creating huge incentives to effect the fundamental transformations through non-bank intermediaries and markets, that is, to build up the 'new shadow-banking' sector.  How this will work is difficult to forecast.  It will be determined by a number of forces, but one worth emphasizing is the changing market infrastructure involving CCP's, custodians, depositories and settlement systems.  The risks will go where the financial flows go.  If these flows remain opaque, data analysis will be inadequate, and systemic risks will be perceived too late, as in 2007-2008.  This is why the aggregation and dissemination of information sources now flowing to trade repositories is a crucial piece of the global effort to promote financial stability. The slides for this talk can be found here.


What lessons should we learn from the most important financial crisis of our time?,  March 2012


This article written in French is based on a talk addressed to a non-specialist audience, given at the Catholic University of Louvain-la-Neuve on December 9, 2011. Noting that all financial crises resemble one another in some respects (excessive borrowing, panic selling of assets, etc.) I ask what is special about the crisis that we have been experiencing since 2007.  I review the major stages in the development of the crisis from its early signs of distress in the American mortgage market up to the sovereign debt crisis in the Euro Zone that was being discussed at the European Summit in Brussels as I spoke.  Along the way I draw out four major lessons that I argue should be the studied carefully by all who are concerned with understanding the management of major financial institutions, prudential regulation and the conduct of fiscal and monetary policy.  A copy of the paper is available for download hereThis has now appeared as "Quelles Leçons Tirer de la Grande Crise Finacière Nôtre Temps?" Regards Economiques Num 96, mai 2012.



Regulatory Reform and the Changing Landscape of Banking,  October 2011


In this speech delivered to the Alumni Association of the Luxembourg School of Finance I argue that the changes that are being made to the regulation of banking and financial markets more generally have unleashed very strong forces that will change dramatically the landscape of global finance in the years to come. Under the aegis of G-20 regulatory reforms have a common thrust in Europe and North America.  While much of the discussion of the crisis that emerged in 2007 has emphasized the importance of systemic risks that traditional prudential regulation was ill-equipped to solve, subsequently only slight progress has been made in the development of "macro prudential regulation."   Instead, the existing Basel framework has been reinforced with steep increases in regulatory capital, the introduction of two liquidity requirements, and a proposed leverage ratio be applied to total assets unadjusted for riskiness. The scale of these changes to Basel are not easy to assess, but recent research based on line of business analysis of the top dozen or so global investment banks and universal banks suggest that the impact of changes to Basel would bring return on equity down from about 20% in a benchmark case to about 7% under the new regulations if the banks were to keep their same portfolio of activities.  In fact, banks will respond massively in the face of changed incentives.  The changes of strategy will involve improvements in risk management and capital allocation systems, portfolio rebalancing, and shedding of unprofitable business to varying degrees depending upon the position of the bank.  In the near-term the last course of action is likely to be the most attractive to shareholders, and there are currently a wide variety of portfolio carve-outs that are being proposed to big-money, non-bank investors. If large banks are retreating from global finance, who will fill the gap?  We argue that the names of the new leader institutions are difficult to predict.  However, collectively these emerging institutions will satisfy the huge, latent global demand for financial intermediation.   This will involve transformation of credit quality, maturity and liquidity just as did the old shadow banking sector that stepped into the the lime light in 2008. In the new shadow banking sector, the vehicles and players may be different than in the past.  But stripped down, the economics will be the same.  A copy of the paper is available for download here.


Ownership and Control in Bail-In and Special Resolution, March 2011


This short paper was written for a high level workshop that we held at LSE to discuss the possible implementation of a bail-in facility as part of a special resolution regime for Systemically Important Financial Institutions (SIFIs). The main attraction of bail-in is that it may be much less costly to tax payers and to society generally than resolution under standard bankruptcy law because it is aimed at maintaining the "going-concern" value of the bank. In our paper we argue that a key component of the design of the regime is to assure a continuity of managerial control even though the ownership structure of the bank will undergo change as part of bail-in.  We suggest that this might be achieved through the means of a "golden share" that will be allocated to the regulatory authorities for the duration of the SIFI's spell in special resolution.  A copy of this note can be found here.  The papers circulated at the workshop give a good overview of the state of thinking on bail-in in spring 2011. The can be found on the FMG website at .  Following the workshop the participants circulated a minute of the main points where there was a convergence of views.  A copy of this minute can be found here.  Much of the thinking that emerged at the workshop appears to be reflected in a July 2011 publication of the Financial Stability Board entitled "Effective Resolution of Systemically Important Financial Institutions" which can be found at .    


Credit Default Swaps: What are the social benefits and costs?, Banque de France Financial Stability Review, July 2010


Credit Default Swaps (CDS) are derivative contracts that allow agents to shift the risk of default on an underlying credit from a credit protection buyer to a credit protection seller.  Like other derivatives they are standardized relative to the underlying cash markets and in this way can help promote market liquidity.  This in turn can facilitate risk shifting and price discovery.  In this way they may lead to accurate pricing of credit risk and ultimately to the reduced costs of borrowing.  However, like other derivatives it is possible that CDS contracts could play a part in market manipulations, especially when the underlying cash market is not transparent.  This is a potential cost of CDS trading that should be weighed against potential benefits of liquidity, risk shifting and price discovery.  We discuss the balance of these trade-offs in the context of single-name corporate CDS, index CDS, sovereign CDS and CDS on structured credit product tranches.  We also discuss other potential costs of CDS trading including that they ``make selling short too cheap'' and that they may create market instability by facilitating speculative attacks.  A copy of the paper is available for download here. This article was the subject of a Q&A in the Wall Street Journal's Market Beat.


The Global Financial Crisis: What Lies Ahead? April 2009


This talk was given to a group of investors in Abu Dhabi.  As the world economy recovers from the current recession, investors will be confronted with continuing high volatility of the key benchmark prices including interest rates, foreign exchange and key commodities. The most important driver of this volatility will be monetary policy in the US while the Fed tries to exit from quantitative easing.  As global production recovers, the current account imbalances will emerge along similar lines as the early part of this decade, that is, with China, Emerging Asia and the Middle East recording very large current account surpluses.   As in the past, the world financial system will be pushed to recycle these surpluses in the form of correspondingly large net capital flows to the deficit countries.  At the same time this system will be reshaped by regulatory changes including higher regulatory capital charges for banks, reduced reliance on credit ratings, and attempts at systemic coordination under the leadership of the Fed and, for the first time, the ECB.  Currently, profit (and loss) opportunities abound with macro strategies in executed with plain vanilla instruments. In time however securitised credit products and credit derivatives will find their way back into the mainstream of credit creation generally.  This will be led by smaller investment banks and funds aimed at specialized areas of corporate finance and structuring.  Long-term, these players will join forces with the new banking giants based in Emerging Asia and the Middle East.  A copy of the paper is available for download here.


Sense and Nonsense in the Current Debate about Credit Derivatives March 2009


In this contribution to the current policy debate on financial regulation, I argue that some of the strongest critics of credit derivatives have been mistaken in focussing on credit default swap (CDS) as the main contributor to the banking crisis of 2007-2008.  Problems in this market will be greatly reduced with the on-going expansion of Central Counterparty Clearing.  The main remaining concern is that information on aggregated positions of counterparties be effectively transmitted to the authority responsible for monitoring systemic risk.  More problematic is the issue of achieving greater transparency about risks in CDO's, CLO's and other structured credit products.  Here the excessive reliance on ratings has meant that information relevant to assessing risks has been systemically discarded.  Worse still, no one has been incentivised to collect and transmit this information.  Addressing this problem will require regulators to look at the whole information process along the entire originate-to-distribute product chain.  A copy of the paper is available for download here.





How Do Finance Specialists Think? Talk in the LSE series of "How Social Scientists Think" January 2008


In this talk for non-specialists  I explain what I understand to be the key ideas that run through academic and practitioner work on financial questions and which define the intellectual make-up of finance specialists.  I trace the development of finance to works of economists who studied problems of savings and investment.  I argue that finance as a distinctive discipline began to emerge only after the tools needed to analyse choice making under uncertainty, notably expected utility theory and the notion of state-contingent claims, were available.  However the core ideas that are shared by finance scholars and that distinguish them from other social sciences grew out of the study of no-arbitrage restrictions in complete markets.  I trace the development of this theory from the 1958 contribution of Modigliani and Miller through the generalizations of Black-Scholes theory up to about 1980 when the main elements of the theory were complete.  I then sketch some of the strands of finance research since then which have explored the consequences of a variety of financial market imperfections.  I conclude that there is no unified theory of "imperfect capital markets".  Nevertheless, there is shared implicit goal of achieving a body of thinking on imperfect markets which is as consistent and comprehensive as the theory of no-arbitrage in complete markets but which can stand up to empirical testing. A copy of the paper is available for download here.


Financing for Long-term Growth in an Integrating World Economy.

(Ferring Pharmaceuticals Annual Review 2004)


In this short article I present some of the insights of dynamic corporate finance that are relevant to practitioners. I argue that in a dynamic context a firm’s financial policy should be chosen not only as related to existing activities but also with a view to how financial structure will affect the firm’s ability to undertake future growth opportunities. I discuss the implications of this for leverage, firm liquidity and hedging.  A copy of the paper is available for download here.