Skip to main content

Preventing Financial Fires

Which is the more glamorous occupation: fire fighter or fire prevention officer? Which is the more important? Let's think of the financial analogy. Which is the more glamorous: dealing with financial crises or designing policies to prevent future crises? Once the crisis is over and fixed, politicians and the public have little interest in designing policies to prevent future collapses as such things do not capture the public imagination. In addition, bankers have every incentive to resist policies designed to prevent future crises because they are costly to implement.  Click here to read Robert Shiller's take on this.

The existence of a fire service which quickly and efficiently reacts to fires means that, unless compelled by the government, people and firms under-invest in fire prevention. Indeed, there is even the possibility that the existence of such a fire service increases the probability and severity of fires. The same holds true in finance. The existence of bailouts and government rescue schemes means that banks will under-invest in risk management and end up taking greater risks. Is it time to get rid of the financial rescue service or is it time to get tough with banks?

Popular posts from this blog

The Economics of Global Warming

The Berkeley Earth Project , an independent study of global warming, has found that the earth has become a degree warmer over the past half century.  However, the statistical uncertainty surrounding pre-1920 estimates makes it very hard to say much about long-term trends - click here for graph .  This is one of my concerns with the global warming debate - we simply don't have trustworthy long-run data which looks at temperature changes over the last millennium (or two).  My second concern with the global warming debate is that it is very hard to prove any sort of casual link between global warming and human activity.  The scientists may be able to show correlation between global warming and our production of carbon dioxides etc., but correlation is not causation. My third concern with the debate is  that those who are sceptical or agnostic are stereotyped as flat-earthers or intellectually-challenged crackpots.  This only stifles debate and the progress of science itself. 

Boom and Bust: A Global History of Financial Bubbles

Boom and Bust: A Global History of Financial Bubbles, co-authored with my colleague Will Quinn , is forthcoming in August. It is published by Cambridge University Press and is available for pre-order at Amazon , Barnes and Noble , Waterstones and Cambridge University Press . 

The Failure of Herstatt Bank

As an undergraduate, I was taught about the failure of Herstatt Bank in 1974 and Herstatt risk. This bank was only the 35th largest bank in Germany at the time so why would anyone be interested in studying its failure? Herstatt failed because of its involvement in risky foreign exchange business. When it closed its doors on 26 June 1974, counterparty banks (mainly in New York) had not received dollars due to them because of time-zone differences - this is known as settlement risk. The cross-jurisdictional implications of its failure resulted in the Bank for International Settlements setting up the Basel Committee on Banking Supervision and Herstatt's failure was a key reason for the establishment of real-time gross settlements systems, which ensures that payments between two banks are executed in real time. The Bank of England's Ben Norman has an interesting post on Herstatt over at the Bank's new blog ( Bank Underground ). As well as giving an excellent overview of