Arnold Kling  

R&R: It's the Leverage, Stupid

Nobel for Institutional Econom... Economic Models, the Bond Mark...

Reinhart and Rogoff are interviewed. Rogoff says,

This idea that we'll get rid of too-big to fail banks and we'll be OK -- that's nuts because a really big bank is only going to fail if there's a systemic crisis. But if there's a systemic crisis a lot of little banks are going to fail too, and it's not credible that your going to let so many little banks go. The government needs to have much stronger regulation on short-term borrowing to try to prevent the short-term leverage buildups that the financial system tends to gravitate towards. That's a recurrent theme across most of the crises that we looked at. There's a huge build-up of short-term leverage somewhere in the system -- could be consumers, corporates, the government -- and it gives this false sense of profitability and sustainability that collapses when confidence is lost.

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COMMENTS (3 to date)
SydB writes:

Big is not necessarily bad. Big makes it easier to track performance--whether it be big banks and their leverage or wall mart and its use of certain types of products.

Floccina writes:

Is it true that when interest rates are trending down, it pays to borrow short and lend long?
Is it possible that interest rates trended down for to long could cause problems?
Should teh Fed buy long term bonds if the gap between short term and long term interest rates grow to much to fast.

Anonymous Coward writes:

This is serious?
Um...We already have rules against excessive leverage.
If a bank leverages more than a certain % its declared insolvent and taken by the FDIC. In the past a bank collapsed when it couldn't pay its creditors, like any other business, nowadays a bank collapses when the regulators say it does.

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