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How Big Banks Fail and What to Do about It [Kindle Edition]

Darrell Duffie
5.0 out of 5 stars  See all reviews (4 customer reviews)

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Book Description

Dealer banks--that is, large banks that deal in securities and derivatives, such as J. P. Morgan and Goldman Sachs--are of a size and complexity that sharply distinguish them from typical commercial banks. When they fail, as we saw in the global financial crisis, they pose significant risks to our financial system and the world economy. How Big Banks Fail and What to Do about It examines how these banks collapse and how we can prevent the need to bail them out.

In sharp, clinical detail, Darrell Duffie walks readers step-by-step through the mechanics of large-bank failures. He identifies where the cracks first appear when a dealer bank is weakened by severe trading losses, and demonstrates how the bank's relationships with its customers and business partners abruptly change when its solvency is threatened. As others seek to reduce their exposure to the dealer bank, the bank is forced to signal its strength by using up its slim stock of remaining liquid capital. Duffie shows how the key mechanisms in a dealer bank's collapse--such as Lehman Brothers' failure in 2008--derive from special institutional frameworks and regulations that influence the flight of short-term secured creditors, hedge-fund clients, derivatives counterparties, and most devastatingly, the loss of clearing and settlement services.

How Big Banks Fail and What to Do about It reveals why today's regulatory and institutional frameworks for mitigating large-bank failures don't address the special risks to our financial system that are posed by dealer banks, and outlines the improvements in regulations and market institutions that are needed to address these systemic risks.



Editorial Reviews

Review

"[T]his volume will give readers a deeper understanding of how modern banking works."--Choice

"There are precious few manuals on global finance. To be sure, there are enough leaden textbooks and scholarly tomes to crush many a library, but there are few nuts-and-bolts guides. Darrell Duffie has performed a great service by attempting to explain in simple terms why and how major investment banks (what he calls 'dealer banks') collapse. . . . How Big Banks Fail is . . . a valuable addition to public literature on the global financial crisis."--Joel Campbell, International Affairs

"This is a clear and readable account of the mechanisms and incentives at play."--Saxon Brettell, Business Economist

"I highly recommend the book. I believe the text should be standard reading for anybody involved with regulating and supervising financial institutions as it offers valuable insights into the plumbing of financial markets and the mechanisms that can cause bank failures. The discussed mechanisms are thought provoking and can provide researchers and regulators with valuable ideas for future research on the financial system as well as banking regulation."--Jan Wrampelmeyer, Financial Markets and Portfolio Management

From the Inside Flap

"In How Big Banks Fail and What to Do about It, Darrell Duffie tackles one of the central but often neglected issues in building a more resilient financial system. Duffie has that rare combination--the rigor of the academy and knowledge of how the plumbing of the financial system works. Anyone interested in regulatory reform will need to engage with his thinking."--Paul Tucker, deputy governor, financial stability, Bank of England

"The book does an excellent job of explaining the institutional setting of big dealer banks and how things went wrong in the financial crisis. The issues are important and the policy suggestions sound. There is nothing quite like this out there."--Franklin Allen, University of Pennsylvania

"Darrell Duffie is one of the leading experts on the problem of large-bank failures. He focuses on issues not addressed elsewhere, but which are being talked about everywhere. This book scores in a big way."--Viral V. Acharya, New York University


Product Details

  • File Size: 475 KB
  • Print Length: 112 pages
  • Publisher: Princeton University Press (October 18, 2010)
  • Sold by: Amazon Digital Services, Inc.
  • Language: English
  • ASIN: B004KZQKEQ
  • Text-to-Speech: Enabled
  • X-Ray:
  • Lending: Not Enabled
  • Amazon Best Sellers Rank: #542,864 Paid in Kindle Store (See Top 100 Paid in Kindle Store)
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12 of 12 people found the following review helpful
5.0 out of 5 stars An important book for resolving large banks in future December 25, 2010
Format:Hardcover|Verified Purchase
This book tackles a highly important theme facing regulation of large, complex financial institutions (LCFI's). Darrell Duffie is one of the leading scholars in institutions and markets in which these institutions participate, and which often render their bankruptcy resolution difficult. The combination of the topical theme and the scholarly work and thinking that Professor Duffie brings to the table make this book a great read. It is also likely to an influential manuscript as regulators the world over grapple with developing a credible resolution authority for orderly liquidation of LCFI's.

In the academic literature on bank and bank failures, a bank simply fails or it does not fail. When it fails, it is either liquidated at a cost or it is bailed out by regulators. In some cases, there is the issuance of equity possible at time of liquidation but by and large it is ruled out based on arguments that equity issuance is very costly. The liquidation point is also assumed to be reached suddenly and abruptly. As a result, this literature is somewhat distant from the actual realities and complexities of how banks fail, what is the set of chain reactions that arises, why certain types of banks (such as broker-dealers) fail so swiftly, and why it is so hard to restructure them. For instance, it is often assumed that renegotiation of debt in models is infeasible or fully feasible (as it is with a monolithic creditor). But when one talks about banks, there are all kinds of counterparties involved with different bankruptcy exemptions. The stage is thus set right for someone to lay at the outset what the issues are in some detail, and what the possible solutions might be.
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2 of 3 people found the following review helpful
5.0 out of 5 stars A Forensic Analysis of Bank Failures January 15, 2011
Format:Hardcover
In this essay Stanford Professor Darrell Duffie makes the general public aware of the mechanisms that can bring big banks, identified above all as dealer banks, so rapidly to failure. Since such types of financial institutions rely heavily on more convenient short-term financing, mainly through repurchase agreements, it is essentially a lack of cash or liquidity that produces an almost sudden death for dealer banks. The analysis, carried almost like a forensic autopsy, recalling the collapses of Lehman Brothers and Bear Stearns, describes that the driving key force that leads to fatal consequences is of behavioral kind. Namely, once hit by huge unexpected losses, such big banks start dedicating more and more buffer stocks and liquidity securities just to signal their strength to their clients, while continuing to make two-sided market quotations as well in most cases, despite the associated increasing drain of cash. Such a mechanism of increased risk taking, while incurring losses, reminds in many aspects of the well known behavioral phenomenon of loss aversion, described by Kahneman and Tversky (1979). Therefore, we should consider solutions to mitigate ex-post the costs of the systemic risk intrinsic in bank failures, such as in particular, as suggested by Darrell, the full establishment of centralized counter parties (CCP's) or clearing houses. However, in order to at least attempt at preventing those disastrous failures, we should try to intervene ex-ante as well, and discourage excessive risk taken by dealer bank executives, by forcing them to share the negative outcomes of their sometimes reckless behavior. For example, the bonus scheme adopted in 2008 by the dealer bank Credit Suisse to pay their executives through the same bad assets they dealt with their clients could be considered as an enlightening case of such disincentive mechanisms.
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6 of 10 people found the following review helpful
Format:Hardcover
This book does give a detailed account of what happened to create the Great Recession and why the Great Recession of 2007-2009 is still going on ,irrespective of the nonsense claims peddled by economists that the recession ended at the end of June ,2009. The three major factors making the Great Recession inevitable were (a) the repeal of the Glass-Steagall Act(GS) of 1933 in 1999 , (b) the passage of the Commodities Futures Modernization Act (CFMA) of 2000,and (c) the planned and organized restructing of the American banking system ,started by Jimmy Carter in 1978,to create mega sized banks through periodic waves of mergers,acquisitions and takeovers.It should be emphasized that the major supporters of these actions in the late 1980's to 2000 were Bill and Hilary Clinton,F D Raines,Rubin ,Summers, Senator Dodd,Barney Frank,Senator Schumer and the usual array of Libertarian Republican supporters of Wall Street casino capitalisn ,such as Phil and Wendy Gramm.Repealing Glass Steagall allowed the private comercial banks to again set up investmant bank units to engage in financial speculation.This was the primary problem that occurred in the mid to late 1920's.Highly speculative,leveraged ,margin account loans financed the stock market bubble while balloon payment loan financing of mortgages created the bubble in housing.This double bubble led directly to the Great Depression of the 1930's. The same type of double bubble led to the Great Recession of the 2000's.

The CFMA removed derivatives and credit default swaps(CDS's) from any regulation at the state and federal level.Derivatives,CDS's and CDO's(Collateralized Debt Obligations)played the role in the 2000's that margin account financing of stock options had played in the 1920's.
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