Better Than Before: The Post-Crisis Financial System


[MUSIC] The people’s whose jobs it is as
professionals or as educators, or as regulators to go deep into the details
of the workings of the financial system. I’m guessing if you ask 100 of them,
95 would say we’re far more resilient now than we
were in 2007, traumatically so. [MUSIC] Post crisis, the Dodd–Frank Act does
impose Additional requirements. Higher capital requirements for banks when they have these
securities on their balance sheets. Enormous fines to the banks for
any miss-selling of mortgage products. Skin in the game requirements that
require the originators to keep a slice of these secularization
on their own balance sheets so that they have to eat
whatever they feed to others. And these requirements were enough to make the market a lot safer. It’s not only that they have a lot more
cap, there’s a lot more transparency now. So in the derivatives markets for example, most of the off exchange
derivatives are now reported, where regulators can see them. And the standard derivatives
are centrally cleared and clearing houses were there more safely
to risk managed in case someone, one of the largest derivatives
traders were to fail, those positions would be managed
by clearing house rather than causing immediate contagion into
the rest of the financial system. [MUSIC] The banks are much better capitalized
now than they were before the crisis, dramatically so. And yet when they get credit
from wholesale bond investors, the bond investors are asking for
much higher compensation in yield for
bearing the risk of default losses. Now, how do you square those two facts? First the banks are much safer,
much less likely to fail. And secondly, bond investors
are requiring much more compensation for bearing losses associated
with bank failure. There’s only one reasonable
explanation in my mind, and that’s the perception
by investors that we’re a large US bank to get into
trouble in the future. The government is not
going to bail them out. The government is not going to make those
bonds whole, the difference between the likelihood that big banks got bailed
out before the financial crisis versus the likelihood that they would get bailed
out in the future there’s dramatic. It’s a significant reduction and the probability of bailout that’s
implied by those market prices. [MUSIC] Imagine a very large bank on death’s door. Or maybe it’s just getting
under-capitalized and the government has lost patience
with the managers of the bank. And has become concerned that the bank may
fail and cause problems for the economy. Now, regulators have on their dashboard
a big red button called bail in. If they hit that button then
the bank will go through a failure resolution process by which
overnight the debts of the bank are eliminated,
a large fraction of them are eliminated. And the creditors that were owed those
debts are no longer creditors to the bank they are now
shareholders in the bank. And they therefore, will suffer the losses that the taxpayers
might have otherwise suffered. That process is called bail in. And of course there are it’s
a complicated process and is being implemented in different
ways in different countries. Within the United States it’s taken
quite seriously by bond investors. That’s one of the reasons that they
no longer believe in too big to fail, is that they know that that red button, is sitting on the desk of the regulators
waiting to be hit when the time comes. And that the plans for
this failure resolution, have been fairly methodically worked out. [MUSIC] The day and in which we say okay,
the system is great, and let us just keep it going the way
it is that day is still far off. But in terms of the US financial
system collapsing because of a shock like the one that occurred in 2007,
it’ll happen someday. But it’s not going to happen nearly
as frequently as it would have given the situation that we faced
before the financial crisis. [MUSIC]

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