OECD - The Current Financial Crisis – Causes and Policy Issues (2)

Article "The Current Financial Crisis – Causes and Policy Issues" in (OECD)’s website
PDF file

The second part of the report is on policy issues.
Some highlights:

Crisis Management
Three basic and separable steps to deal with a banking system solvency crisis:
1. Guarantee liabilities to stop bank runs.

2. Separate the good assets from the bad assets, and get the bad assets off bank balance sheets

method 1: ‘asset management’ approach to buying toxic assets
e.g TARP in its initial form; actions during Asia Crisis

method 2: nationalise banks, separate the bad assets, and then sell the cleaned-up banks back to the private sector.
e.g approach used in Scandinavia in 1991; Resolution Trust Corporation (RTC) in US’s Savings and Loans (S&L) Crisis

Method 3: Encourage a large better capitalised bank to take over a smaller failing bank and absorb its losses

3. Recapitalise the asset-cleansed banks by finding new equity holders, via selling common shares or preference shares to private entities or government

Exit Strategy and Long Term Reform
3 areas:
1. Reform in incentive systems
2. Matching cost of capital to the risks that institutions actually take, by regulatory influence
3. Exit government bank ownership and insurance commitments through asset sales and debt management techniques.

Its "Figure 4. Incentive structure, influences and outcomes" shows main channels of influence. It is an insightful summary.

Some concepts that I think worthwhile to learn about and explore further:
Theory of the second best :
if market failures are present then reforms to improve pieces of the system (as opposed to reforming the global interactions between regulatory, tax, remuneration and other governance factors, etc.) may not help and indeed may make things worse.

Basel I and Basel II : to match capital regulation with the riskiness of bank lending
Capital rules : pro-cyclical
end result: not able to avert financial crisis.

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