JP Morgan (JPM) and Systemic Risk - 0 views
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On Thursday we learned that JP Morgan has lost over $2 billion in the space of two weeks
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one likely scenario ([1], [2]) involves derivatives constructed from the riskier components of some European corporate bonds.
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recent paper by Stanford Professor Darrell Duffie highlights an unresolved weakness in the U.S. financial system
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Each day something like $100 billion in such short-term lending is intermediated by two clearing banks
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Duffie believes the system is inherently unstable, as dealer banks depend crucially on the ability and willingness of the clearing banks to provide short-term financing each new day
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Here is Duffie’s recommendation for how to make the tri-party clearing system more stable: Given the systemic importance of tri-party clearing agents, and given their high fixed costs and additional economies of scale, tri-party repo clearing services for U.S. dealers and cash investors should probably operate through a dedicated regulated utility. Although this would likely increase operating costs for market participants, it would enable investment in more advanced clearing technology and financial expertise, allowing greater resilience of the tri-party repo market in the face of financial shocks such as the default of a major dealer. The moral hazard associated with lending of last resort to a dedicated utility is much reduced relative to the case of a financial institution with a wide scope of risk-taking activities.
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this week’s news should remind us that more needs to be done to ensure financial stability and that the incentives of private participants align with the public’s best interests