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.
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