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Financial Stability

Paper Session

Friday, Jan. 4, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, Marquis Ballroom A
Hosted By: American Economic Association
  • Chair: Jean Tirole, Toulouse School of Economics, IAST & UT1C

Liquidity and Securitization

Douglas Diamond
,
University of Chicago
Yunzhi Hu
,
University of North Carolina
Raghu Rajan
,
University of Chicago

Abstract

In the run up to the financial crisis, the essential functions intermediaries played seemed to become less important. Commercial and industrial loans, as well as residential mortgages, the quintessential banking products, were securitized and sold. At the same time, the “skin in the game” intermediaries held in their activities (including in securitizations) diminished, while their leverage increased. Some have suggested these developments stemmed from rising agency problems in the financial sector. Instead, we attribute the diminution of traditional intermediation activities, as well as the reduced intermediaries’ skin in the game, to rising liquidity in real asset markets. Under a variety of circumstances, prospective liquidity tends to enhance leverage, which crowds out both internal and external corporate governance as supports to debt. This tends to make debt returns more skewed. We develop a more general theory of the interaction between intermediary activities, intermediary capital structure, and real asset market liquidity.

Shadow Banking and the Four Pillars of Traditional Financial Intermediation

Emmanuel Farhi
,
Harvard University
Jean Tirole
,
Toulouse School of Economics

Abstract

Traditional banking is built on four pillars: SME lending, deposit taking, access to lender of last resort and deposit insurance, and prudential supervision. This paper unveils the logic of the quadrilogy by putting core services to "special depositors and borrowers" at the heart of the analysis, and makes room for bank and depositor implicit and explicit guarantees. It analyzes how prudential regulation must adjust to the emergence of shadow banking. The model also rationalizes structural remedies to counter syphoning and financial contagion: ring-fencing between regulated and shadow banking and the sharing of liquidity in centralized platforms.

Liquidity Regulation, Bail-ins and Bailouts

Mathias Dewatripont
,
Free University of Brussels
Jean Tirole
,
Toulouse School of Economics

Abstract

When liquidity requirements for banks were introduced in the wake of the 2008 financial crisis, policymakers received little academic guidance on specific questions such as the measure of the liquidity buffer, its possible decomposition into multiple tiers, and the treatment of interbank exposures, of the securitization of legacy assets, and of systemic stress. Similarly, the introduction of layers of ``bail-inable'' liabilities occurred without conceptual framework on the consistency between liquidity and solvency regulations. The paper develops such a framework, integrates the asset and liability sides into an overall design of prudential regulation and assesses the regulatory reforms.
Discussant(s)
Arvind Krishnamurthy
,
Stanford University
Guillaume Plantin
,
Sciences Po
Anil Kashyap
,
University of Chicago
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
  • G2 - Financial Institutions and Services