The Eurozone is weak. This column presents an analysis of its two prime weaknesses – the lack of economic and fiscal policy discipline leading to the build-up of huge public and private debt levels and a loss of competitiveness, and the lack of credible mechanisms for crisis response that would reign in moral hazard problems and establish market discipline. Completing the currency union’s architecture and achieving credibility for its rules are key, given the heterogeneity and rigidity of its member countries' economies.
Lars P Feld, Christoph M Schmidt, Isabel Schnabel, Volker Wieland, 07 September 2015
Xavier Vives, 17 March 2015
The 2007–08 crisis revealed regulatory failures that had allowed the shadow banking system and systemic risk to grow unchecked. This column evaluates recent proposals to reform the banking industry. Although appropriate pricing of risk should make activity restrictions redundant, there may nevertheless be complementarities between these two approaches. Ring-fencing may make banking groups more easily resolvable and therefore lower the cost of imposing market discipline.
Dirk Niepelt, 21 January 2015
Recent experience with the zero lower bound on nominal interest rates, and the use of high-denomination notes by criminals and tax evaders, have led to revived proposals to phase out cash. This column argues that abolishing cash may be neither necessary nor sufficient to overcome the zero lower bound problem, and would severely undermine privacy. Allowing the public to hold reserves at central banks could reduce the need for deposit insurance, although the transition to the new regime and the effects on credit supply must be carefully considered.
Xavier Vives, 22 December 2014
Banking has recently proven much more fragile than expected. This column argues that the Basel III regulatory response overlooks the interactions between different kinds of prudential policies, and the link between prudential policy and competition policy. Capital and liquidity requirements are partially substitutable, so an increase in one requirement should generally be accompanied by a decrease in the other. Increased competitive pressure calls for tighter solvency requirements, whereas increased disclosure requirements or the introduction of public signals may require tighter liquidity requirements.
Claudio Michelacci, Hernán Ruffo, 18 November 2014
Like any insurance mechanism, unemployment benefits involve a trade-off between risk sharing and moral hazard. Whereas previous studies have concluded that unemployment insurance is close to optimal in the US, this column argues that replacement rates should vary over the life cycle. Young people typically have little means to smooth consumption during a spell of unemployment, while the moral hazard problems are minor – regardless of replacement rates, the young want jobs to improve their lifetime career prospects and to build up human capital.
Kuniyoshi Saito, Daisuke Tsuruta, 14 November 2014
In Japan, loans with 100% guarantees account for more than half of all loans covered by public credit guarantee schemes, but banks claim that they do not offer loans without sufficient screening and monitoring even if the loans are guaranteed. This column presents evidence of adverse selection and moral hazard in Japanese credit guarantee schemes. The problem is less severe for loans with 80% guarantees.
Bruno Biais, Jean-Charles Rochet, Paul Woolley, 21 August 2014
The Global Crisis has intensified debates over the merits of financial innovation and the optimal size of the financial sector. This column presents a model in which the growth of finance is driven by the development of a financial innovation. The model can help explain the securitised mortgage debacle that triggered the latest crisis, the tech bubble in the late 1990s, and junk bonds in the 1980s. A striking implication of the model is that regulation should be toughest when finance seems most robust and when innovations are waxing strongly.
Pierre-Cyrille Hautcoeur, Angelo Riva, Eugene N. White, 02 July 2014
The key challenge for lenders of last resort is to ameliorate financial crises without encouraging excessive risk-taking. This column discusses the lessons from the Banque de France’s successful handling of the crisis of 1889. Recognising its systemic importance, the Banque provided an emergency loan to the insolvent Comptoir d’Escompte. Banks that shared responsibility for the crisis were forced to guarantee the losses, which were ultimately recouped by large fines – notably on the Comptoir’s board of directors. This appears to have reduced moral hazard – there were no financial crises in France for 25 years.
Friðrik Már Baldursson, Richard Portes, 06 January 2014
In 2008, Icelandic banks were too big to fail and too big to save. The government’s rescue attempts had devastating systemic consequences in Iceland since – as it turned out – they were too big for the state to rescue. This column discusses research that shows how this was a classic case of banks gambling for resurrection.
Kaushik Basu, Joseph Stiglitz, 02 January 2014
The Eurozone crisis exposed weaknesses in the Eurozone’s design. This column – by Nobelist Joe Stiglitz and World Bank Chief Economist Kaushik Basu – argues that the Eurozone’s financial architecture can be improved by amending the Treaty of Lisbon to permit appropriately structured cross-country liability for sovereign debt incurred by EZ members.
Thomas Huertas, María J Nieto, 19 September 2013
To end moral hazard, investors, not taxpayers, should bear the loss associated with bank failures. Recently, the EU took a major step in this direction with the Banking Recovery and Resolution Directive. This column argues that this is a game changer. It assures through the introduction of the bail-in tool that investors, not taxpayers, will primarily bear the cost of bank failures, and it opens the door to resolving banks in a manner that will not significantly disrupt financial markets.
Eduardo Cavallo, Eduardo Fernandez-Arias, 17 October 2012
The Eurozone body politic seems to be slowly learning the lessons for crisis management. This column argues that Latin America’s decades of financial crisis can provide key insights for Europe.
Charles Wyplosz, 26 September 2011
Last weekend, Eurozone policymakers were shaken into admitting that something more needs to be done to save the Eurozone and avoid a major crisis that would reverberate around the world. This column proposes a three-step solution to finally end the crisis.
Hans Gersbach, 02 April 2011
When banks failed, the government paid up. But the bankers responsible kept their bonuses from the years of excess. This column argues for “crisis contracts”. Such contracts require that, in the event of a crisis, bank managers forfeit a portion of their past earnings to rescue the banking system.
Russell Cooper, Hubert Kempf, 18 February 2011
Before the surprising 2007 collapse of Northern Rock, it was taken for granted that bank runs were things of the past. But their return and the modifications of deposit insurance schemes lead many to question the credibility of the government’s commitment. What makes a run on a bank? And when should the government intervene? This column provides some answers.
Federico Etro, 04 November 2010
Looking at the contracts for large oil paintings in Italy (1550-1750), this column finds evidence of strong competition between painters. Contracts were structured to address moral hazard problems, and prices closely reflected demand and supply conditions in an integrated market.
John Van Reenen, 04 May 2010
How can financial regulation be fixed to avoid another global crisis? This column argues that the “heads, I win; tails, society loses” moral hazard in the financial sector has to stop. To do this, policymakers must make bankruptcy credible. If a company has too much debt and becomes insolvent, it should suspend payments and its shareholders and creditors should lose their money.
Brian Bell, John Van Reenen, 03 May 2010
The global crisis has sharpened the media spotlight and political debate on bankers’ bonuses. Focusing on evidence from the UK, this column argues that to avoid excessive risk-taking in the financial sector and exploitation of moral hazard, bankers’ bonuses should be based on risk-adjusted long-run performance or be subject to “clawback” if future performance declines.
Stefano Micossi, 16 March 2010
Policymakers and commentators have suggested that large banks should be broken up. This column argues that such an idea risks the very existence of a global financial system. It outlines an alternative framework in which deposit insurance should be covered by banks not taxpayers, banks should not be guaranteed a bailout, and regulators should be mandated to step in when the warning signs begin.
Ricardo Caballero, 17 November 2009
How should governments respond to sudden failure of the financial system? This column says that it is neither credible nor desirable to refuse to assist the private sector in financial crises. It makes the case for massive provision of credible public insurance and guarantees to financial transactions and balance sheets – a financial defibrillator to respond to sudden financial arrest.