TABLE OF CONTENTS
Introduction - Brunnermeier Markus, Krishnamurthy Arvind
DOI: 10.7208/chicago/9780226092645.003.0001
[triggers, vulnerabilities, liquidity, macroeconomics, crises, risk topography, real estate]
This chapter introduces the importance of measuring risks to form a comprehensive "risk topography" of the economy. The book is comprised of a series of blocks, or set of chapters, each one discussing a different facet of the issue. These include issues of conceptual measurement, risk exposures, factors that may indicate vulnerability, such as liquidity and leverage, intermediary funding and lending, and finally the real estate sector. The chapters in this book are particularly focused on vulnerabilities that can lead to amplified response to negative shocks. As a large part of the risk is endogenous and self-generated by the system, the measurement can only be understood in connection with general equilibrium models. Measurements will allow researchers and regulators to discriminate across models and improve our understanding of macrofinancial links. (pages 1 - 12)
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Challenges in Identifying and Measuring Systemic Risk - Hansen Lars Peter
DOI: 10.7208/chicago/9780226092645.003.0002
[systemic risk, modeling, measuring, empirical constructs, financial markets, macroeconomy]
Sparked by the recent "great recession" and the role of financial markets, considerable interest exists among researchers within both the academic community and the public sector in modeling and measuring systemic risk. In this chapter, I draw on experiences with other measurement agendas to place in perspective the challenge of quantifying systemic risk, or more generally, of providing empirical constructs that can enhance our understanding of linkages between financial markets and the macroeconomy. In addition, I explore some conceptual modeling and measurement challenges, and examine these challenges as they relate to existing approaches to measuring systemic risk. (pages 15 - 30)
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Regulating Systemic Risk through Transparency Trade-Offs in Making Data Public - Landier Augustin, Thesmar David
DOI: 10.7208/chicago/9780226092645.003.0003
[disclosure, regulatory environment, costs and benefits, data, maximize welfare, economic frictions, transparency]
Public or partial disclosure of financial data is a key element in the design of a new regulatory environment. We study the costs and benefits of higher public access to financial data and analyze qualitatively how frequency, disclosure lag and granularity of such open data can be chosen to maximize welfare, depending on the relative magnitude of economic frictions. We lay out a simple framework to choose optimal transparency of financial data and, in doing so, address the following questions: At what frequency should data be collected and made available? How long should the regulator wait before releasing data? And, at what level of detail should information be released? (pages 31 - 44)
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Systemic Risk Exposures A 10-by-10-by-10 Approach - Duffie Darrell
DOI: 10.7208/chicago/9780226092645.003.0004
[10-by-10-by-10, network-based, stressful scenarios, market value, cash flow, risk magnitudes, economic values, liquidity, counterparty failure]
This chapter presents and discusses a “10-by-10-by-10” network-based approach to monitoring systemic financial risk. Under this approach, a regulator would analyze the exposures of a core group of systemically important financial firms to a list of stressful scenarios, say 10 in number. For each scenario, about 10 such designated firms would report their gains or losses. Each reporting firm would also provide the identities of the 10 counterparties with whom the gain or loss for that scenario is the greatest in magnitude relative to all counterparties. The gains or losses with each of those 10 counterparties would also be reported, scenario by scenario, measured in terms of market value and also in terms of cash flow, allowing regulators to assess risk magnitudes in terms of stresses to both economic values and also liquidity. Exposures would be measured before and after collateralization. One of the scenarios would be the failure of a counterparty. The “top ten” counterparties for this scenario would therefore be those whose defaults cause the greatest losses to the reporting firm. The number “10” is, thoughout, arbitrary. (pages 47 - 56)
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Remapping the Flow of Funds - Begenau Juliane, Piazzesi Monika, Schneider Martin
DOI: 10.7208/chicago/9780226092645.003.0005
[flow of funds, credit market positions, credit market instruments, payment streams, book value]
The Flow of Funds Accounts are a crucial data source on credit market positions in the U.S. economy. In particular, they combine regulatory data from various sources to produce a consistent set of flow and stock tables in major credit market instruments by sector. The events of the last five years have underscored the importance of positions data to guide economic analysis. Viewing positions as payment streams typically requires more information than book value or fair value. However, much of this information is already contained in the data sets from which the Flow of Funds accounts are constructed. This chapter first argues that quantitative analysis of credit market positions would benefit tremendously if the additional information about the structure of payment streams were more readily available, and derives some concrete alternatives for data collection. (pages 57 - 64)
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Measuring Margin - McDonald Robert L.
DOI: 10.7208/chicago/9780226092645.003.0006
[derivatives, trading activity, asset class, measuring, reporting, margin, Dodd-Frank]
Policy makers and market participants alike wish to understand the amount, economic significance, and concentration of derivatives trading activity. This paper suggests that systematic measuring and reporting of margin by market participants, disaggregated by asset class, would provide more meaningful insights into derivatives activity. Where margin is not required, it could nevertheless be imputed and reported. The Dodd-Frank financial reform bill, by contrast, moves away from transparency by granting nonfinancial firms an end-user exemption from posting initial margin on their trades. This is economically equivalent to a borrowing from the counterparty and effectively permits these firms to issue offbalance-sheet debt. (pages 65 - 82)
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A Transparency Standard for Derivatives - Acharya Viral V.
DOI: 10.7208/chicago/9780226092645.003.0007
[derivatives, financial institutions, exposures, transparency standard, current standard, disclosures, margin coverage ratio]
Derivatives exposures across large financial institutions often contribute to - if not necessarily create - systemic risk. Current reporting standards for derivatives exposures are nevertheless inadequate for assessing these systemic risk contributions. In this paper, I explain how a transparency standard, in contrast to the current standard, would facilitate such risk analysis. I also demonstrate that such a standard is implementable by providing examples of existing disclosures from large dealer firms in their quarterly filings. These disclosures often contain useful firm-level data on derivatives, but due to a lack of standardization, they cannot be aggregated to assess the risk to the system. I highlight the important contribution that reporting the "margin coverage ratio" (MCR), namely the ratio of a derivatives dealer's cash (or liquidity, more broadly) to its contingent collateral or margin calls in case of a significant downgrade of its credit quality, could make toward assessing systemic risk contributions. (pages 83 - 96)
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Liquidity Mismatch Measurement - Brunnermeier Markus, Gorton Gary, Krishnamurthy Arvind
DOI: 10.7208/chicago/9780226092645.003.0008
[liquidity, systemic risk, aggregate liquidity, measurement, stress scenario, asset and liability]
Policymakers and academics recognize that liquidity is central in the dynamics of a financial crisis, and that measurement of liquidity is critical in evaluating and regulating systemic risk. Systemic risk depends primarily on the endogenous response of market participants to extreme events. The liquidity measure is a key response indicator and aggregate liquidity measures are important to detect a buildup of systemic risk in the background during a run-up phase. The purpose of this chapter is to examine the measurement of liquidity in light of the academic research on liquidity. What is the practical and measured counterpart of the theoretical concept of liquidity suggested by models? If one is interested in a liquidity measure that is informative about systemic risk, what measure does the academic research suggest? We discuss a liquidity (risk) measure that is computed conditional on stress scenarios. For each stress scenario and for each asset and liability a cash equivalent dollar value is assigned. The dollar values are aggregated to form a liquidity mismatch index at the level of a firm. The chapter discusses how this metric can be used to gauge systemic risk. (pages 99 - 112)
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Monitoring Leverage - Geanakoplos John, Pedersen Lasse Heje
DOI: 10.7208/chicago/9780226092645.003.0009
[leverage, interest rate, systemic risk, debt-equity ratio, monitor, loans, collateral values]
We argue that leverage is a central element of economic cycles and discuss how leverage can be properly monitored. While traditionally the interest rate has been regarded as the single key feature of a loan, we contend that the size of the loan, i.e., the leverage, is in fact a more important measure of systemic risk. Indeed, systemic crises tend to erupt when highly leveraged economic agents are forced to deleverage, sending the economy into recession. We emphasize the importance of measuring both the average leverage on old loans (which captures the economy's vulnerability) and the leverage offered on new loans (which captures current credit conditions) since the economy enters a crisis when leverage on new loans is low and leverage on old loans is high. While leverage plays an important role in several economic models, the data on leverage is model-free and simply needs to be collected and monitored. (pages 113 - 128)
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Repo and Securities Lending - Adrian Tobias, Begalle Brian, Copeland Adam, Martin Antoine
DOI: 10.7208/chicago/9780226092645.003.0010
[repo, securities lending, institutional arrangement, data collection, monitoring]
We provide an overview of the data required to monitor repo and securities lending markets for the purposes of informing policymakers and researchers about firm-level and systemic risk. We start by explaining the functioning of these markets and argue that it is crucial to understand the institutional arrangements. Data collection is currently incomplete. A comprehensive collection would include, at a minimum, six characteristics of repo and securities lending trades at the firm level: principal amount, interest rate, collateral type, haircut, tenor, and counterparty. (pages 131 - 148)
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Improving Our Ability to Monitor Bank Lending - Bassett William F., Gilchrist Simon, Weinbach Gretchen C., Zakrajšek Egon
DOI: 10.7208/chicago/9780226092645.003.0011
[provision of credit, bank lending activities, measuring bank lending, credit flow, analysis, regulatory reports, bank-intermediated credit]
In this chapter, we highlight some of the difficulties that arise in measuring accurately the provision of credit by the banking sector during an economic downturn, such as the one experienced during the recent financial crisis. Specifically, we argue that existing bank regulatory reports provide insufficient detail to monitor banks' lending activities accurately. We then outline a conceptual framework for measuring bank lending that could be used to improve the existing information on banks' on-balance-sheet lending activities and the equally-important information on banks' offbalance-sheet credit line provision activities. We recognize that the literal adoption of our framework would increase banks' reporting burden. Our aim, rather, is to provide a detailed description of the kind of data that would significantly inform the analysis of credit flows and greatly enhance our ability to assess the availability of bank-intermediated credit. (pages 149 - 162)
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The Case for a Credit Registry - Mian Atif
DOI: 10.7208/chicago/9780226092645.003.0012
[credit registry, bank credit, supply-side factors, fluctuations, methodology, database]
This chapter seeks to answer this question: What tools does a regulator or policy maker have at his/her disposal to judge whether changes in bank credit are driven by supply-side factors? A methodology that could help policy makers better understand the extent to which supply side factors generate aggregate fluctuations in credit is examined. The methodology is based on the regulator having access to a timely and comprehensive credit registry that contains information on every business loan given out by the banking sector. While such credit registry data are available in many countries around the world, the U.S. does not currently have a comparable system. This chapter discusses the design issues related to building up a credit registry database, outlines the methodology that could be applied to credit registry data to isolate the role of supply-side factors, provides real world examples, and concludes with a discussion of some of the limitations of the methodology. (pages 163 - 172)
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Monitoring the Financial Condition and Expenditures of Households - Hall Robert E.
DOI: 10.7208/chicago/9780226092645.003.0013
[monitor, household expenditure, data sources, cutbacks, deleverage, consumption]
Households purchase about two-thirds of the output of the U.S. economy and, inevitably, cutbacks in household expenditure accounted for a large fraction of the decline in GDP in the recession. As households went on a spending binge in the middle of the 2000s, they built up an unusually high stock of housing, cars, and other durable assets, along with a large volume of debt to finance the spending. The crisis resulted in a large volume of household deleveraging-households contracted consumption to pay off debt. Although the available data shows household expenditure during the recession, charting purchases of new houses, and consumer goods and services from 2001 onwards, the existing data sources could be improved. In order to better monitor household expenditure, online and administrative sources not currently being tapped could add a great deal of information. (pages 175 - 182)
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LEADS on Macroeconomic Risks to and from the Household Sector - Parker Jonathan A.
DOI: 10.7208/chicago/9780226092645.003.0014
[household leverage, household balance sheet, macroeconomic risks, consumer spending, shifting losses, aggregate consumption, household financial data, portfolio risks]
This chapter describes a system, called the LEADS system, for providing market participants, regulators, and households with information on the reallocation of resources within, from, and to the household sector in response to macroeconomic events. The household sector is both a propagator of shocks to the economy, as wealth is redistributed across households with differing propensities to consume, and an originator of risky claims held in systemically important places, as losses are shifted from households to creditors such as financial institutions. Information about these exposures, like information generally, is conveyed by prices and so is underproduced by markets. The LEADS system - collection, analysis, and distribution of information on household exposures to macroeconomic risk factors - can potentially lead to better macroeconomic performance through better informed public policy and private decision- making. (pages 183 - 204)
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Detecting “Bad” Leverage - Sufi Amir
DOI: 10.7208/chicago/9780226092645.003.0015
[leverage, household leverage, supply, productivity, credit, borrowers, elasticity, asset prices, debt levels]
This chapter seeks to answer the following question: how do regulators and policy makers know when a large increase in leverage will end badly? The answer to this question lies in the ability to detect whether an increase in household leverage is due to an expansion in the supply of credit or whether it is due to improvements in the productivity of borrowers. The strategy studied here is using microeconomic data on borrowers with a high elasticity of borrowing with respect to credit availability to isolate the supply versus productivity effects. If a sharp increase in leverage is due primarily to an increase in the supply of credit, the regulator has reason to be concerned. There are three facts that motivate the methodology: (1) when fueled by an expansion in the availability of credit, dramatic increases in leverage typically end badly, (2) there is a segment of the U.S. population that displays a very high elasticity of borrowing with respect to credit availability, and (3) asset prices are often a function of debt levels. (pages 205 - 212)
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A Macroeconomist's Wish List of Financial Data - V. V. Chari
DOI: 10.7208/chicago/9780226092645.003.0016
[financial market disturbances, broader economy, equilibrium models, financial frictions, nonfinancial firms, publicly traded, privately held, financial intermediaries]
Developing an understanding of how financial market disturbances affect the broader economy is crucial for designing regulatory policy on financial markets. Recent research on general equilibrium models with financial frictions offers a great deal of promise in understanding links between financial markets and the rest of the economy. In particular, many recent models focus on how frictions in financial markets impede firms' investment decisions. Further development of this class of models may require data on the financial statements of nonfinancial firms. Such data is available for publicly traded firms but is not available for privately held firms in the United States. Such data is available from the tax returns that corporations file, as well as the statements firms make available to financial intermediaries when they seek to borrow funds, but detailed data on individual firms is not publicly available. (pages 215 - 232)
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Systemic Risks in Global Banking What Available Data Can Tell Us and What More Data Are Needed? - Cerutti Eugenio, Claessens Stijn, McGuire Patrick
DOI: 10.7208/chicago/9780226092645.003.0017
[global financial stability, international financial system, crossborder banking risks and exposures, financial networks and connections, consistent international data, closing data gaps, ongoing initiatives]
The recent financial crisis has shown how interconnected the financial world has become. Shocks in one location or asset class can have a sizable impact on the stability of institutions and markets around the world. But systemic risk analysis is severely hampered by the lack of consistent data that capture the international dimensions of finance. While currently available data can be used more effectively, supervisors and other agencies need more and better data to construct even rudimentary measures of risks in the international financial system. Similarly, market participants need better information on aggregate positions and linkages to appropriately monitor and price risks. Ongoing initiatives that will help in closing data gaps include the G20 Data Gaps Initiative, which recommends the collection of consistent bank-level data for joint analyses and enhancements to existing sets of aggregate statistics, and the enhancement to the BIS international banking statistics. (pages 235 - 260)
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