Policy Issues Concerning the Reform of the Credit Rating Agencies

Proposes creating a private board of securitization market participants with a public mandate to set standards and encourage their adoption, improving transparency and realigning the incentives of rating agencies and others with those of final investors

PICES-GLOBEC International Program on Climate Change and Carrying Capacity: Report of the 1999 MONITOR and REX Workshops, and the 2000 MODEL Workshop on Lower Trophic Level Modelling

Table of Contents [pdf, 0.11 Mb] Executive Summary [pdf, 0.07 Mb] MODEL Task Team Workshop Report Final Report of the International Workshop to Develop a Prototype Lower Trophic Level Ecosystem Model for Comparison of Different Marine Ecosystems in the North Pacific [pdf, 11.64 Mb] Report of the 1999 MONITOR Task Team Workshop [pdf, 0.32 Mb] Report of the 1999 REX Task Team Workshop Herring and Euphausiid population dynamics Douglas E. Hay and Bruce McCarter Spatial, temporal and life-stage variation in herring diets in British Columbia [pdf, 0.10 Mb] Augustus J. Paul and J. M. Paul Over winter changes in herring from Prince William Sound, Alaska [pdf, 0.08 Mb] N. G. Chupisheva Qualitative texture characteristic of herring (Clupea pallasi pallasi) pre-larvae developed from the natural and artificial spawning-grounds in Severnaya Bay (Peter the Great Bay) [pdf, 0.07 Mb] Gordon A. McFarlane, Richard J. Beamish and Jake SchweigertPacific herring: Common factors have opposite impacts in adjacent ecosystems [pdf, 0.15 Mb] Tokimasa Kobayashi, Keizou Yabuki, Masayoshi Sasaki and Jun-Ichi Kodama Long-term fluctuation of the catch of Pacific herring in Northern Japan [pdf, 0.39 Mb] Jacqueline M. O’Connell Holocene fish remains from Saanich Inlet, British Columbia, Canada [pdf, 0.40 Mb] Elsa R. Ivshina and Irina Y. Bragina On relationship between crustacean zooplankton (Euphausiidae and Copepods) and Sakhalin-Hokkaido herring (Tatar Strait, Sea of Japan) [pdf, 0.14 Mb] Stein Kaartvbeedt Fish predation on krill and krill antipredator behaviour [pdf, 0.08 Mb] Nikolai I. Naumenko Euphausiids and western Bering Sea herring feeding [pdf, 0.07 Mb] David M. Checkley, Jr. Interactions Between Fish and Euphausiids and Potential Relations to Climate and Recruitment [pdf, 0.08 Mb] Vladimir I. Radchenko and Elena P. Dulepova Shall we expect the Korf-Karaginsky herring migrations into the offshore western Bering Sea? [pdf, 0.75 Mb] Young Shil Kang Euphausiids in the Korean waters and its relationship with major fish resources [pdf, 0.29 Mb] William T. Peterson, Leah Feinberg and Julie Keister Ecological Zonation of euphausiids off central Oregon [pdf, 0.11 Mb] Scott M. Rumsey Environmentally forced variability in larval development and stage-structure: Implications for the recruitment of Euphausia pacifica (Hansen) in the Southern California Bight [pdf, 3.26 Mb] Scott M. Rumsey Inverse modelling of developmental parameters in Euphausia pacifica: The relative importance of spawning history and environmental forcing to larval stage-frequency distributions [pdf, 98.79 Mb] Michio J. Kishi, Hitoshi Motono & Kohji Asahi An ecosystem model with zooplankton vertical migration focused on Oyashio region [pdf, 33.32 Mb] PICES-GLOBEC Implementation Panel on Climate Change and Carrying Capacity Program Executive Committee and Task Team List [pdf, 0.05 Mb] (Document pdf contains 142 pages

Real Estate Booms and Banking Busts: An International Perspective

Real estate cycles and banking cycles may occur independently but they are correlated in a remarkable number of instances ranging over a wide variety of institutional arrangements, in both advanced industrial nations and emerging economies. During the recent Asian financial crisis, the most seriously affected countries first experienced a collapse in property prices and a weakening of the banking systems before experiencing their exchange rate crises. Countries where banks play a more dominant role in real estate markets and hold a greater percentage of assets are the most severely affected during such a crisis. In this paper, the authors develop an explanation of how real estate cycles and banking crises are related and why they occur. The authors first discuss how real estate prices are determined and why they are so vulnerable to deviations from long-run equilibrium prices, paying special attention to the role of the banking system in determining prices. Increases in the price of real estate may increase the economic value of bank capital to the extent that banks own real estate. This then increases the value of loans collateralized by real estate and may lead to a decline in the perceived risk of real estate lending. For these reasons, an increase in real estate prices may increase the supply of credit to the real estate industry which is then likely to lead to further increases in real estate prices. The opposite is also true. A decline in the price of real estate will decrease bank capital by reducing the value of the bank's own real estate assets as well as reduce the value of loans collateralized by real estate. This may lead to defaults, thus further reducing capital. A decline in the price of real estate is also likely to increase the perceived risk in real estate lending. All of these factors reduce the supply of credit to the real estate industry. Supervisors and regulators may also react to the resulting weakening of bank capital positions by increasing capital requirements and instituting stricter rules for classifying and provisioning against real estate assets, leading to even further decline in prices and supply of credit to the real estate industry. In order to explain how real estate cycles begin, the authors turn to a model of land prices developed by Mark Carey that details the role of optimists in the process. They then bring in the role of non-financial variables as well as of banks and then turn to the part played by "disaster myopia" -- the tendency over time to underestimate the probability of low-frequency shocks -- in determining cycles. Other factors that contribute to cycles are inadequate data and weak analysis by bank managers as well as "perverse incentives" -- one result of "disaster myopia" that occurs when lenders believe that they can accept higher loan-to-value rations, weaker commitments or guarantees and looser loan covenants without increasing their risk of loss. Using this framework of the interactions between the real estate market and bank behavior, the authors interpret recent examples of real estate booms linked to banking crises in Sweden, the United States, Japan and Thailand. They then discuss measures that can be taken to limit the amplitude of real estate cycles and ways to insulate the banking system from real estate cycles. They believe that the heart of the problem is the structure of the real estate market and that cycles can be avoided by taking measures that counter: The bias towards optimism; Excessive leverage; Disaster myopia; Inadequate data and weak analysis; Perverse incentives. The authors detail their recommendations for avoiding these problems in the future. These include the development of an options market for commercial real estate, greater reliance on equity financing, changes in supervisory policy that allow the identification of vulnerable banks before they become weak banks, better publication of information relevant to the valuation of commercial real estate projects, and refraining from providing full protection to all bank creditors, especially sophisticated creditors such as corporations, banks, and institutional investors.

The Case of the Missing Market: The Bond Market and Why It Matters for Financial Development

Over the last decade interest in the role of finance in economic growth has revived. Building from the pioneering work of Goldsmith (1965) and the insights of Shaw (1973) and McKinnon (1973), the more recent work examines the role of financial institutions and financial markets in corporate governance and the consequent implications for economic growth and development. Levine (1997) and Stulz (2000) have provided excellent reviews of this literature and Allen and Gale (2000) have extended it by developing a framework for comparing bank-based financial systems with market-based financial systems. Although the literature addresses "capital markets," on closer inspection the main focus is really equity markets. Bond markets are almost completely overlooked. Although the omission of the bond market is not defended in the literature, one could argue that it does little violence to reality. As Table 1 shows, in most emerging economies in Asia, bond markets are very small relative to the banking system or equity markets. Moreover, the most striking theoretical results flow from a comparison of debt contracts with equity contracts and at a high level of abstraction bank lending can proxy for all debt. In any event, data are much more readily available for equity markets and the banking system than for bond markets, even in the United States.

Liquidity Shocks, Systemic Risk, and Market Collapse: Theory and Application to the Market for Perps

Traditional explanations of market crashes rely on the collapse of an asset price bubble or the exacerbation of an information asymmetry sufficient to cause less-informed participants to withdraw from the market. We show that markets can crash even though asset prices have not deviated from fundamental values and information is shared symmetrically among all market participants. We present a model in which markets crash when investors shift their beliefs about the liquidity of the secondary market. While such shifts in liquidity may be a factor in explaining many market crashes, the collapse of the market for perpetual floating-rate notes (perps) provides an especially clear illustration of the theory because a shift in liquidity beliefs appears to have been the sole determinant of the market crash. Such a shift can be precipitated by a systemic liquidity shock that is transitory or permanent. The latter proved to be the case with perps because perceptions of the liquidity of the secondary market were permanently altered. In addition to providing new insights into why markets crash, our findings are particularly relevant for unseasoned financial products that are often priced and marketed on the assumption that liquid secondary markets will develop. The perp episode also highlights the importance of broad placement of securities. Since market liquidity arises endogenously from the diversity of liquidity needs across the investor base, the broader the investor base, the lower the probability of a systemic liquidity shock. We also show how simple modifications in security design can mitigate the impact of such a shock should it occur.

What Is Optimal Financial Regulation?

The financial system is regulated to achieve a wide variety of purposes. However, the objective that distinguishes financial regulation from other kinds is that of safeguarding the economy against systemic risk. Concerns regarding systemic risk focus largely on banks, which traditionally have been considered to have a special role in the economy. The safety nets that have been rigged to protect banks from systemic risk have succeeded in preventing banking panics, but at the cost of distorting incentives for risk taking. Regulators have a variety of options to correct this distortion, but none can be relied upon to produce an optimal solution. Technological and conceptual advances may be ameliorating the problem, nonetheless. Banks are becoming less special. The US is leading the way, but the trends are apparent in other industrial countries as well. The challenge facing regulators is to facilitate these advances and hasten the end of the special status of banks. Once banks have lost their special status, financial safety nets may be dismantled thus ending the distortions they create. Ultimately, regulation for prudential purposes may be completely unnecessary. The optimal regulation for safety and soundness purposes may be no regulation at all.

The Role of the Financial Sector in Economic Performance

What distinguished financial institutions from other firms is the relatively small share of real assets on their balance sheets. Thus, the direct impact of financial institutions on the real economy is relatively minor. The indirect impact of financial markets and institutions on economic performance is extraordinarily important. The financial sector mobilizes savings and allocates credit across space and time. It provides not only payment services, but also enables firms and households to cope with economic uncertainties by hedging, pooling, sharing and pricing risks. An efficient financial sector reduces the cost and risk of producing and trading goods and services and thus makes an important contribution to raising the standard of living. The authors begin their analysis by considering how an economy would perform without a financial sector and then proceed to introduce a simplified financial sector with direct financial transactions between savers and investors. Financial intermediaries are introduced which transform the direct obligations of investors into indirect obligations of financial intermediaries which have attributes that savers prefer. This approach emphasizes how the financial sector can improve both the quantity and quality of real investment and thereby increase income per capita. The authors then consider the role of government in supporting an efficient financial sector. However, the authors show that not all government intervention is beneficial. They demonstrate the potentially detrimental effects of regulation on both the financial structure and the real economy. They also emphasize the competitive forces that influence the ultimate impact of regulations. Technological trends in telecommunications and computation seem likely to increase the ease with which users and providers of financial services can circumvent burdensome regulations, according to the authors. This has led to calls for reduction in the overall restrictions on financial firms, as well as for international harmonization of regulations regarding safety and soundness, insider trading and taxation. The authors examine how to quantify the gains to the economy from improving the efficiency of the financial sector and the potential social gains and costs which may result from the formation of financial conglomerates. The authors then consider pressures for international harmonization of financial regulation, contrasting institutional regulation with functional regulation. The authors conclude that efficient financial markets require an infrastructure of laws, conventions and regulation. Most of all, an efficient financial system requires confidence. Confidence encourages investors to allocate their savings through financial markets and institutions rather than to buy non-productive assets as a store of value. The authors suggest that such confidence can be fostered by appropriate regulation of institutions and markets to ensure users of financial services that they will receive fair treatment. According to the authors, the challenge is to foster a static and dynamically efficient financial system while maintaining sufficient regulatory oversight to promote confidence in the safety and soundness of the financial system.

The Role of Capital in Financial Institutions

This paper examines the role of capital in financial institutions. As the introductory article to a conference on the role of capital management in banking and insurance, it describes the authors' views of why capital is important, how market-generated capital requirements' differ from regulatory requirements and the form that regulatory requirements should take. It also examines the historical trends in bank capital, problems in measuring capital and some possible unintended consequences of capital requirements. According to the authors, the point of departure for all modern research on capital structure is the Modigliani-Miller (M&M, 1958) proposition that in a frictionless world of full information and complete markets, a firm s capital structure cannot affect its value. The authors suggest however, that financial institutions lack any plausible rationale in the frictionless world of M&M. Most of the past research on financial institutions has begun with a set of assumed imperfections, such as taxes, costs of financial distress, transactions costs, asymmetric information and regulation. Miller argues (1995) that these imperfections may not be important enough to overturn the M&M Proposition. Most of the other papers presented at this conference on capital take the view that the deviations from M&M s frictionless world are important, so that financial institutions may be able to enhance their market values by taking on an optimal amount of leverage. The authors highlight these positions in this article. The authors next examine why markets require' financial institutions to hold capital. They define this capital requirement' as the capital ratio that maximizes the value of the bank in the absence of regulatory capital requirements and all the regulatory mechanisms that are used to enforce them, but in the presence of the rest of the regulatory structure that protects the safety and soundness of banks. While the requirement differs for each bank, it is the ratio toward which each bank would tend to move in the long run in the absence of regulatory capital requirements. The authors then introduce imperfections into the frictionless world of M&M taxes and the costs of financial distress, transactions costs and asymmetric information problems and the regulatory safety net. The authors analysis suggests that departures from the frictionless M&M world may help explain market capital requirements for banks. Tax considerations tend to reduce market capital requirements , the expected costs of financial distress tend to raise these requirements , and transactions costs and asymmetric information problems may either increase or reduce the capital held in equilibrium. The federal safety net shields bank creditors from the full consequences of bank risk taking and thus tends to reduce market capital requirements . The paper then summarizes the historical evolution of bank capital ratios in the United States and the reasons regulators require financial institutions to hold capital. They suggest that regulatory capital requirements are blunt standards that respond only minimally to perceived differences in risk rather than the continuous prices and quantity limits set by uninsured creditors in response to changing perceptions of the risk of individual banks. The authors suggest an ideal system for setting capital standards but agree that it would be prohibitively expensive, if not impossible. Regulators lack precise estimates of social costs and benefits to tailor a capital requirement for each bank, and they cannot easily revise the requirements continuously as conditions change. The authors continue with suggestions for measuring regulatory capital more effectively. They suggest that a simple risk-based capital ratio is a relatively blunt tool for controlling bank risk-taking. The capital in the numerator may not always control bank moral hazard incentive; it is difficult to measure, and its measured value may be subject to manipulation by gains trading . The risk exposure in the denominator is also difficult to measure, corresponds only weakly to actual risk and may be subject to significant manipulation. These imprecisions worsen the social tradeoff between the externalities from bank failures and the quantity of bank intermediation. To keep bank risk to a tolerable level, capital standards must be higher on average than they otherwise would be if the capital ratios could be set more precisely, raising bank costs and reducing the amount of intermediation in the economy in the long run. Since actual capital standards are, at best, an approximation to the ideal, the authors argue that it should not be surprising that they may have had some unintended effects. They examine two unintended effects on bank portfolio risk or credit allocative inefficiencies. These two are the explosive growth of securitization and the so-called credit crunch by U.S. banks in the early 1990s. The authors show that capital requirements may give incentives for some banks to increase their risks of failure. Inaccuracies in setting capital requirements distort relative prices and may create allocative inefficiencies that divert financial resources from their most productive uses. During the 1980s, capital requirements may have created artificial incentives for banks to take off-balance sheet risk, and changes in capital requirements in the 1990s may have contributed to a credit crunch.