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The collapse of securitization: From subprimes to

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THE COLLAPSE OF SECURITIZATION:
International FROM
Economic
Institute
SUBPRIMES TO GPolicy
LOBAL CREDIT
RUNCH
Institut International CdEconomie
Politique
International Economic
Policy Institute
Robert Guttmann
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International Economic Policy Institute
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MISSION STATEMENT
The International Economic Policy Institute is a bilingual, non-partisan, non-profit policy research group
(the creation of this Institute is pending university approval) at Laurentian University, Ontario (Canada),
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John Isbister, Senior Researcher, Laurentian University
Aurlie Lacassagne, Researcher, Laurentian University
Brian MacLean, Senior Researcher, Laurentian University
SENIOR RESEACH ASSOCIATES
Amit Bhaduri, Jawaharlal Nehru University (India)
Paul Davidson, New School University (USA)
Robert Dimand, Brock University (Canada)
Roberto Frenkel, University of Buenos Aires (Argentina)
Robert Guttmann, Hofstra University (USA)
Claude Gnos, Universit de Bourgogne (France)
Marc Lavoie, University of Ottawa (Canada)
Noemi Levy, Universidad Nacional Autonoma (Mexico)
Philip A. O'Hara, Curtin University (Australia)
Alain Parguez, Universit de Franche Comt, (France)
Sergio Rossi, University of Fribourg (Switzerland)
Claudio Sardoni, University La Sapienza (Italy)

Mario Seccareccia, University of Ottawa (Canada)

Mark Setterfield, Trinity College (USA)
John Smithin, York University (Canada)
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Mehdi Ben Guirat, The College of Wooster (USA)
Fadhel Kaboub, Drew University (USA)
Dany Lang, National University of Ireland, Galway (Ireland)
Joelle Leclaire, Buffalo State University (USA)
Jairo Parada, Universidad del Norte (Colombia)
Martha Tepepa, El Colegio de Mexico (Mexico)
Zdravka Todorova, Wright State University (USA)

WORKING PAPERS
WP 2008-01
The Political Economy of Interest-Rate Setting, Inflation and Income Distribution
Louis-Philippe Rochon and Mark Setterfield
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The sustainability of sterilization policy
Roberto Frenkel
WP 2009-01
Financing Development: Removing the External Constraint
Hassan Bougrine and Mario Seccareccia
WP 2009-02
An Institutional Perspective on the Current U.S. Government Bailouts
Zdravka Todorova
WP 2009-03
The Sustainability of Fiscal Policy: An Old Answer to An Old Question
Claudio Sardoni
WP 2009-04
A Minsky Moment?The Subprime Crisis and the New Capitalism
Riccardo Bellofiore and Joseph Halevi
WP 2009-05
The Collapse of Securitization: From Subprimes to Global Credit Crunch
Robert Guttmann

STUDENT WORKING PAPERS

WP 2009 01
Prebisch and the Situation of Bolivia Today
Florine Salzgeber

THE COLLAPSE OF SECURITIZATION: FROM

SUBPRIMES TO GLOBAL CREDIT CRUNCH
ROBERT GUTTMANN*

*Robert Guttmann is Professor of Economics at Hofstra University (New York) and professeur associ at
the Universit Paris XIII. He has published widely in monetary theory and on issues of international
finance, including Reforming Money and Finance: Institutions and Markets in Flux (1989), How CreditMoney Shapes the Economy: The United States in a Global System (1994), Reforming Money and
Finance: Toward a New Monetary Regime (1997) and Cybercash: The Coming Reign of Electronic Money
(2003).

________________________________________________________________________
Introduction
While it is still too early to tell where the global credit crunch of 07 will lead us, this
latest financial crisis is well worth analyzing. Acute crisis, with its ruptures, ripples, and
shifts across time and space, reveals qualitative aspects of the systems modus operandi
usually hidden under the veil of normalcy. Any closer look at what has transpired so far
may well show this to have been the first systemic crisis of a new finance-led
accumulation regime and as such an important stress test for an entire infrastructure of
financial markets underpinning this regime.1

The Housing Boom

The origins of the present crisis lay with the decade-long U.S. housing boom and its
denouement in 2006. In the mid-1990s favorable demographic trends (e.g. population
growth), economic conditions (e.g. interest rates, labor market), and socio-political forces
(e.g. ideology of ownership society) came together to set off a boom in real estate that
soon became a key pillar in the resurgence of the U.S. economy. Fuelling that expansion
was the successful launch of a major financial innovation, the securitization of loans,
which transformed the funding of investments in real estate.
The U.S. government, having long supported home ownership with various tax breaks
and subsidies, also set up its own specialized lending institutions to assure a steady
supply of funds to prospective home-owners. Two of these government-sponsored banks,
known as Fannie Mae and Freddie Mac, have grown into the nations second- and third-

For more on the regulationists concept of a finance-led accumulation regime see Aglietta (1998), R.
Boyer (2002), D. Plihon (2003), or B. Coriat, P. Petit & G. Schmder (2006), The notion of systemic risk,
associated with major financial crises, is discussed in M. Aglietta & P. Moutot (1993).

largest lenders respectively, with a combined asset total in excess of $5.2 trillion.2 They
control about half of Americas mortgage market by originating or buying, as well as
insuring and guaranteeing, such home-based loans. In the early 1980s these two quasipublic banks found an ingenious way to accelerate their funding capacity. They bundled
mortgages into pools and then issued bonds that gave investors a claim on income flows
from the underlying loan pool. Offering comparatively attractive yields, such mortgagebacked securities (MBS) were snapped up by a rapidly growing number of investors.
Soon the commercial banks decided to enter the loan-securitization business themselves.
By repackaging their mortgage loans into marketable securities, banks could provide new
intermediation services rich in fee income, transfer default risk, and recuperate loanedout funds quickly to make new loans. Swamped with growing supplies of funds by
investors hungry for the relatively attractive yields offered by these new instruments,
banks went on a lending spree. In the late 1990s they boosted credit demand by making
the refinancing of older mortgages (at lower rates and/or larger amounts) much easier
while at the same time offering so-called home-equity loans. Both of these innovations
raised the borrowing capacity of American homeowners in line with rising housing
prices, allowing them to cash in on their growing wealth without having to sell their
home.
As the boom turned into a self-feeding bubble, from late 2004 to early 2006, banks
accelerated innovation to target borrowers that would not have qualified in more normal
market conditions. So-called piggy-backs, where borrowers take out a second loan to
cover their down-payment, made it possible for homes to be bought entirely on debt, with
no cash required of ones own. Alt-A mortgages offered funds at higher interest rates as
compensation for not asking borrowers to comply with the usual standards of income,
wealth, and credit-history verification. Most important, however, were so-called
subprime mortgages given to households with unfavorable credit histories who would
compensate for increased credit risk by paying higher rates. In 2006 nearly 40% of all
new mortgages were of these non-traditional varieties. The subprime market alone saw
650 securitization deals worth $539 billion.
The rapid take-off of piggy-backs, Alt-As and subprimes was not least due to their
investment-grade ratings by Moody or Standard & Poors which allowed their inclusion
in the loan pools prepared for securitization. Today we know that such high ratings were
not based on objective assessment of default risks, but the result of a conflict of interest
which saw these two rating agencies earn lucrative consulting fees from advising banks
how to compose loan pools that, once securitized, would earn high-enough ratings to be
marketable (see A. Lucchetti and S. Ng, 2007). Nearly every single issue of MBS over
the last three years thus ended up containing a bundle of subprimes carrying similarly or
equally high ratings as the rest of the pool. Investors were lulled into believing that they
were buying very safe securities. Now that the rating agencies have come under heavy
criticism for their initial bias in favor of subprimes, they risk aggravating the crisis
through the precisely opposite reaction of excessive downgrading which render those
2

To finance their operations Fannie Mae and Freddie Mac issue their own bonds, known as agency
securities, which carry comparatively low rates because of implied government backing.

lower-rated securities ineligible for institutional investors (i.e. mutual funds, pension
funds) and hence likely to default.
Moody and Standard & Poors were not the only actors with a vested interest to
downplay risks during the U.S. housing bubble. So did also the assessors, hired by banks
to estimate the value of the real estate serving as the loans collateral, the banks top
managers who paid less attention to the creditworthiness of borrowers now that credit
risk could be transferred to buyers of MBS, and loan officers aggressively pursuing the
higher commissions and rates earned on non-traditional mortgages. Attracting
unsuspecting borrowers with very low interest rates, sometimes as low as 1% for the first
couple of years, the subprime lenders often did not make it sufficiently clear that these
so-called teaser rates would be reset relatively soon to much higher levels, up to 18%.
Many borrowers never bothered to inform themselves properly about the terms of their
mortgage, preferring instead to believe that they could refinance profitably before any
reset would make the existing mortgage more expensive. It is worth noting here that key
Democrats, notably Barack Obama in the Senate and Barney Frank in the House, are
pushing to outlaw a variety of fraudulent practices which the current crisis has revealed to
have become widespread in mortgage lending. Obamas bill wants fines paid into a fund
set up to help subprime borrowers forestall foreclosure.
The housing bubble burst in mid-2006 when gradual tightening by the Fed, with
seventeen consecutive interest-rate hikes over two years, finally started to bite. Housing
sales, construction, mortgage lending, and home prices all started to fall precipitously.
Amidst this pull-back it did not take long for many overextended subprime borrowers to
show signs of stress. When the first major wave of resets towards much higher rates hit in
early 2007, it was suddenly clear that perhaps as many as 20% of the subprimes faced
likely default in the coming year or two especially considering that resets would
continue at very high levels throughout 2008. In June 2007 Moody and Standard &
Poors downgraded hundreds of securities based on subprime loans, many of them now
below investment grade and hence suddenly no longer eligible for pension funds or
mutual funds to invest in. The stage was set for a full-blown financial crisis.

The Breakdown of the Securitization Chain

As is typically the case with major financial crises, it is a single event which triggers a
sudden shift of sentiment from euphoric greed to panicky fear and so causes a sharp
pullback in the credit system. When BNP Paribas suspended two funds on 9 August, its
unexpected announcement unleashed a worldwide chain reaction. The reason given for
the suspension, an inability to price securitized loans properly in the face of widespread
market disorder, revealed that these complex new securities could no longer be priced
properly once their base had been impaired by losses. Nobody knows any longer what
these securities are truly worth. Just as investors had downplayed, even ignored, inherent
risks during the boom, they now went to the opposite extreme of exaggerating those very
risks. It did not help that investors knew from the huge bulge of interest-rate resets

scheduled over the coming year that the subprime crisis would persist throughout 2008
and early 2009.
If you cannot price securities, then you cannot trade them nor use them as collateral. The
market for MBS has, at least for the time being, evaporated. And the spectacular
implosion of that market has frozen a whole layer of even more securitized instruments,
so-called collateralized debt obligations (CDOs). Rising from $80 billion in 2002 to $500
billion in 2007 in new issues, CDOs bundle different kinds of debt, including corporate
bonds, mortgage-backed securities, and credit card debt. Those bundles are then sliced
into tranches which represent different degrees of default risk and, when sold off as
bonds, offer correspondingly higher yields for greater risk (a securitization practice
known as structured finance).
The prospect of contagion by defaulting subprimes and sharply devalued MBS in their
pool has broken the trust in CDOs whose complex and opaque nature makes it impossible
to predict their behavior or figure their value under conditions of stress. As a result
CDOs, even the higher-rated ones, have seen extreme declines in trading volume and
have lost up to 80 percent of their presumed value over the last six months. This has left
the worlds leading financial institutions exposed to potentially huge write-downs, such
as the $8-billion and $11-billion losses announced by Merrill Lynch and Citibank
respectively in short order at the end of October 2007. With an outstanding volume of
subprime- and Alt-A-related CDOs totaling $1.3 trillion, the loss-potential is enormous.
As growing numbers of CDOs get downgraded by Moody or Standard & Poors below
the investment-grade threshold, they go into default mode and trigger forced asset sales
by investors desperate to recover whatever portion of their investments can still be turned
into cash. We have only just started that debt-deflation process.
Not only have some of the worlds leading banks been already hit hard by the collapse of
the CDO market, but other institutions too will see large losses. Many insurance
companies, for instance, have amassed significant CDO holdings, as have pension funds.
Hedge funds too have been heavy buyers of these instruments, using their CDO holdings
as collateral for additional debt to take on. Now that all kinds of financial markets have
seen sharp corrections, the high degree of leverage used by these funds to boost returns
on capital has backfired.3 As falling securities prices have reduced the value of their
holdings, hedge funds are forced to sell off assets, often their best ones, to meet their debt
obligations. That puts enormous pressure on markets for stocks, bonds, structured-finance
products, and currencies. The crisis has also blocked a large number of multi-billiondollar deals which private-equity funds lined up over the past year in a frenzy of
leveraged-buyout attacks that they sought to fund by issuing CDOs.
While these losses will materialize gradually over a year or two, the troubles with CDOs
have also had the more immediate impact of undermining yet another securitization layer
3

The leverage effect, using a lot of debt to keep ones own capital expended to a minimum when acquiring
a portfolio, has the considerable advantage of boosting the return on capital for any given price movement,
provided its direction is correctly anticipated. But just as it boost returns in reward-yielding situations, the
same effect can magnify losses when bets go bad.

 the market for asset-backed commercial paper (ABCPs). The disruption of the ABCPs
in late August and early September 2007 cut off a crucial short-term funding tool for
banks, hedge funds, and private-equity funds to leverage up their operations. This spillover put its bigger cousin, the mainstream commercial-paper market, under pressure as
well. With demand for funds there increasingly expensive or altogether unmet, banks
suddenly faced a huge wave of client requests for immediate liquidity injections. Such
funding requests exploded in the huge inter-bank market just when the banks were
gripped by fear and had their hands full with their own losses (including among conduits
and special-purpose vehicles they had set up to manage their engagements in CDOs and
other securitization products).
With the globally organized inter-bank market becoming quite disorderly in a hurry in
late August 2007, central banks all over the world, in particular the European Central
Bank and even the Federal Reserve, had to inject emergency funds on a massive scale for
a couple of weeks to unblock that chain of interconnected markets. These unprecedented
and coordinated lender-of-last-resort interventions of the top central banks, followed on
September 18 by the Feds surprisingly large interest-cut of half a percent, had the
desired effect of calming the wide range of markets involved and so encourage actors
there to return to more normal behavior. But the crisis is not over. All the central banks
did was buy some time before the next wave of market panic hits.

The Global Growth Dynamic Unhinged

The ongoing credit crunch has raised the prospect of aggravating the U.S. housing
downturn to the point where the American economy slips into recession. Key indicators,
whether job creation, industrial orders, retail sales, or consumer confidence, already point
to significant slowing. Just the near-disappearance of re-financings in the wake of falling
home prices has taken a lot of wind out of the consumers sails. With volume down by
25% and prices 10% lower from the peak, millions of homeowners are getting squeezed
as the value of their equity serving as loan collateral falls below the amount of
outstanding debt. As resets continue, defaults and foreclosures may spread from
subprimes to Alt-As and piggy-backs, finally to the primes. At this point the U.S.
government predicts $200 billion of losses in the $3-trillion mortgage market and over 2
million foreclosures by early 2009. Even these scary numbers may be too low, unless
banks resume normal lending practices. Over the last couple of months U.S. banks, no
longer able to securitize new mortgages and facing large default losses, have significantly
tightened their credit standards for mortgages (see F. Norris and E. Dash, 2007).
Given its size, any slowing of the U.S. economy affects the rest of the world. The United
States has in the past two decades run large trade deficits with other advanced capitalist
countries (Canada, European Union), emerging markets (Brazil, China, India, Russia),
and commodity producers (OPEC) totaling at this point about $850 billion per year (or
6.5% of its GDP). American consumers, their spending levels raised (to an unprecedented
72% of GDP) by the decade-long housing boom, have become buyers of the last resort

for the rest of the world. As the sudden reversal of their fortunes prompts Americans to
spend less, other countries will feel pinched.
The U.S. housing crisis not only undermines export-led growth in the rest of the world,
but also threatens Americas creditors. The United States, like any other excess-spending
country, has to borrow from abroad in order to finance its trade deficits about $2.5
billion every day. America now owes the rest of the world about $3 trillion. Of course,
the U.S. is not like any other debtor nation. Being the issuer of world money, with more
dollars circulating abroad than at home thanks to chronic U.S. balance-of-payments
deficits transferring funds to the rest of the world, the United States is in the
advantageous position of being able to borrow from other nations in its own currency - a
privilege I have elsewhere discussed as global seigniorage (see R. Guttmann, 1994). That
makes foreign debt much less of a burden, since it can be serviced just by issuing new
dollars at home. Without external constraint, Americans can run their economy faster,
borrow more, spend more, save less - to the point where the richest country in the world
now has a negative personal savings rate of minus 2% of disposable household income.
Having increasingly eschewed the low yields of US Treasuries, foreign investors have
gobbled up lots of higher-yielding MBS. Their heavy exposure to Americas mortgagebased securitization layers is now blowing up in their faces. Significant losses have been
announced during the last few months all over the world, by a large number of different
financial institutions, with new surprises every other day.4 These losses have proven
difficult to manage and digest. The new securitized instruments position investors several
layers away from ultimate borrowers, making it difficult to assess their credit-worthiness
and anticipate losses. No one knows when and where losses may arise in the pool. That
systemic lack of predictability is made worse by the fact that most securitized assets are
held off the books, in separate conduits and special-purpose entities. Institutional
investors, from pension funds to hedge funds, try to counter the opaque nature of
securitization instruments (e.g. CDOs, ABCPs) by using highly sophisticated computer
models to price them. But these calculations are only as good as the assumptions on
which they are based. And those imply that there will always be another buyer willing to
take on the risks embedded in the securitized pool of loans. In the midst of a crisisinduced panic such an assumption may evaporate rapidly into thin air, as we have
witnessed already.
While it is impossible to estimate aggregate losses from the credit crunch of 2007 at this
point, we do know that they will be deep and take a year or two to unfold (see, for
instance, G. Tett and P. Davies, 2007). Mortgage defaults could easily end up double or
triple the $100 billion they have cost already so far. Banks may have to write down half
of their holdings in mortgage-backed securities, with possible losses exceeding $500
billion of which the leading banks in the United States, Europe, and East Asia have
barely recognized a third so far. Losses at so-called structured investment vehicles
4

Just during its first month alone (August 2007) the crisis, besides forcing the suspension of two of BNP
Paribas funds, also necessitated the rescues of German bank IKW and British mortgage lender Northern
Rock and sharply higher loss provisions crimping profits of UBS, Deutsche Bank, HSBC, Barclays,
Mackarie, and other lenders across the globe.

(SIVs), bank-controlled funds that use ABCPs and CDOs on both sides of their balancesheet ledgers, already exceed $100 billion and may deepen if, as now seems likely, a
Treasury-supported bail-out plan fails to materialize.5 Losses at other financial
institutions are even harder to predict thanks to more ambiguous loss-accounting rules,
especially as pertains to hedge funds, private-equity funds, and corporate pension funds.
While it is still early in the crisis, the destruction of bank capital in the wake of sharply
lower share prices and large loss charges promises to be significant. Many of the worlds
leading banks will end up seriously undercapitalized, hence in need to cut back their
lending, suspend dividends, and rebuild capital. These recapitalization efforts will, if not
actually triggering a recession, at least depress growth to very low (1-1.5%) levels for the
next couple of years. More dangerous may be the negative mass-psychological impact of
a seemingly never-ending series of loss announcements. The longer investors have reason
to fear future large losses, the greater the erosion of their confidence and the more likely
a recession thanks to mutually feeding lending and spending cutbacks.

Finance-Led Capitalism at a Crossroads

The credit crunch of 2007 raises a number of troubling questions about the modus
operandi of the new finance-dominated accumulation regime. At the heart of this regime
are the banks and the financial markets they support. Both of these are now in distress.
Bankers must ask themselves how they ended up footing such a huge bill for so much
folly. As they ponder this question, they would do well to reconsider the universalbanking model which the worlds leading money-center banks have pursued over the last
couple of decades following the removal of long-standing restrictions on banking
activities (as in the European Commissions Second Banking Directive of 1989 and
Americas Financial Services Modernization Act of 1999). Combining commercial
banking, investment banking (securities), fund management, and insurance, such
integration has made it much easier for banks to introduce new financial products,
organize markets for those instruments, and direct tons of liquidity towards those
markets. The worst-hit banks will be those most exposed to the high-risk segments of the
multi-layered securitization pyramid which they engaged in to compensate for lackluster
performance in other areas of universal banking, as has happened to Citibank, Merrill
Lynch, UBS, Deutsche Bank, Barclays and others (in contrast to, say, better-balanced JP
Morgan Chase, Goldman Sachs, Credit Suisse, or BNP Paribas), Notwithstanding those
individual performance differences, it is dangerous to let our credit system be organized
by institutions that do everything under one roof. You need effective in-house firewalls to keep different activities at proper arms length. Otherwise the temptation for
market manipulation in the throngs of asset bubbles becomes irresistible. We have seen
too many of our banks guilty of such excess. Normal checks and balances, supposedly
carried out by an army of regulators, assessors, rating agencies, intra-firm auditors, and
institutional shareholders, did not work adequately to prevent the crisis we are now
facing.
5

See D. Henry (2007) for more details on the Treasury-favored rescue fund that would use $80 billion to
buy up a chunk of the $350 billion SIV assets.

10

Another troubling question, which the ongoing crisis has put into sharper focus, concerns
the costs and benefits of financial innovation, a major factor in our story. Representing
nothing more than modifications in the terms of contractual promises, new financial
products are easily launched. But their ephemeric nature also preempts their protection by
intellectual property rights and renders them easily copied, The fleeting nature of the
first-comer advantage makes for a very short life cycle in financial-product
development. Banks are therefore under constant pressure to come up with new ideas.
Until now we have generally looked at financial innovation as a positive force. New
channels of financial intermediation, such as securitization, derivatives, and structured
finance, have helped mobilize a huge community of investors on a global scale and
thereby give Americans and other debtors access to cheap funds from all corners of the
world. Such easy access to debt has decoupled income and spending by consumers, hence
allowed for a more stable growth pattern. We have only had two recessions in the last
twenty-five years, both of them shallow and short (1990-91, 2000-01).
But now we are also facing the potentially huge costs of financial innovation exposing
unsuspecting investors to risks that are ill understood and to losses that remain hidden off
the book until they explode with full force into your face. Combining complexity and
opacity, securitization instruments (e.g. MBS, CDOs, ABCPs) have shown themselves
vulnerable to sudden market paralysis. And they all have trading platforms involving
huge amounts of debt that is used by market players for rapid expansion. Such leveraging
is a recipe for great volatility, with any major market disturbance threatening to trigger
self-feeding waves of forced asset liquidations in panic selling. Markets are connected,
and crises thus spread rapidly from one locus of acute instability to others. It is in
retrospect not so surprising that an obscure layer of the U.S. mortgage market could end
up paralyzing the inter-bank market, the nerve center of the global economy.
All this raises the question of the regulatory framework aimed at the structure and
behavioral norms of the banking system. We now know that the checks and balances of
private actors watching each other failed as everyone jumped on the bandwagon of
euphoria and greed during the bubble years. We need to set clearer rules for those actors
with check-and-balance responsibilities, as is currently being discussed in the U.S.
Congress pertaining to mortgage brokers and lenders. And we need more effective
government enforcement of those rules. It is also obvious that the globalized nature of
finance requires a globally coordinated regulatory response. Unfortunately, the crisis has
revealed the limitations of a major effort currently under way in this direction
worldwide implementation of the new capital-adequacy requirements for banks under the
auspices of the Bank for International Settlements (BIS), known as Basel II. This new
system of supervised self-regulation lets banks determine their own minimum
capitalization levels in return for using the most advanced and increasingly sophisticated
methods to measure risks.6 Unfortunately, banks have seen the actual multiplier dynamic
of the credit crunch fall outside the range of scenarios captured by their risk-assessment
6

Basel II seeks to encourage rapid progress by banks in terms of managing default risk, market risk
(applying to price fluctuations in markets for securities, derivatives, and currencies), as well as operational
risks.

11

models. In other words, bankers could not imagine a crisis dynamic like that. Their
models project measurable outcomes, hence assume that there is always someone else
willing to buy at some price when you are willing to sell. These models thus take the
possibility of risk transfer as a given, provided the price is right. But the crisis has shown
us that, once even relatively limited impairments have put into doubt the viability of the
base underpinning the layers of securitized products, there is no way to price these claims
reasonably, hence no market for them. What are risk-measurement models worth, once
all your risk-transfer mechanisms are blocked in a generalized collapse of market
confidence?
Long periods of stability, such as the one we have just gone through, breed their own
financial fragility by encouraging debtors to take on too much debt and creditors to
underestimate risks.7 The credit crunch of 2007 may well be a warning that once again, as
in the late 1960s, we have arrived at a crossroads where a golden period gives way to
much more turbulence. If this is true, then the questions pertaining to the re-regulation of
finance will certainly gain urgency. How can the monetary authorities combine their
triple role of regulating banks, managing crises as lenders of last resort, and conducting
monetary policy? How can they do this effectively while under pressure from the investor
community for tough anti-inflation policies during normal times and massive liquidity
injections during periods of crisis? Will the central banks be able to cooperate effectively
in the face of typically global crises? What are the needed reforms of the BIS, the
International Monetary Fund, the World Bank, and other multilateral institutions so that
they may contribute productively to the stability of our economic system? And how can
these institutional reforms be put into place in coherent fashion while our international
monetary system is moving from six decades of dollar domination to a more multi-polar
system where several currencies the US dollar, the euro, soon perhaps also Chinas
yuan - compete for global leadership and, with it, the benefit of seigniorage? The slow
fuse of the US subprime debacle may give us plenty of opportunity to seek responses to
these questions eventually.

This is a key argument in the theory of H. Minsky (1964, 1982).

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