A leading finance expert explains how and why big banks fail--and what
can be done to prevent it
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.
