Complex Financial Institutions and Systemic Risk

Manuel A. Utset

Florida State University College of Law

Georgia Law Review, Vol. 45, 2011
FSU College of Law, Public Law Research Paper No. 497
FSU College of Law, Law, Business & Economics Paper No. 11-5

This Article takes a novel approach to the “too-big-to-fail” problem. It begins by asking a foundational question: given the extraordinary volume of transactions between complex financial institutions, what mechanisms do these institutions use to deal with the transactional risks created by their mutual complexity? I explore two general approaches available to them. A party can acquire information to pierce through the complexity - an information-intensive strategy. But since information costs increase with complexity, at some point the costs will be so great that a party will enter into the transaction only if it can transact “blindly”. A blind strategy is one in which one party treats the other as a “black box” and protects itself by using other types of contractual mechanisms. I develop a theory of “blind-debt” contracting and show that a debtholder can transact blindly by taking sufficient collateral and making maturities infinitesimally small. In the period leading to the recent crisis, financial institutions increasingly turned to overnight repos - which are essentially, collateralized overnight debt - to finance their operations. As the maturity of repos became increasingly short they began to resemble a second type of blind debt - demand deposits. As institutions became increasingly dependent of blind debt they open themselves to the same type or “runs” to which demand deposit accounts are susceptible. I then develop various legal implications, particularly with regard to the Dodd-Frank Act.

Number of Pages in PDF File: 61

Keywords: financial and banking regulation, financial institutions, Dodd-Frank, repos, short-term debt, derivatives, contagion, bank run, systemic risk, leverage, liquidity, risk management, monitoring, transparency, complexity, too-big-to-fail, intermediation, coordination failures, herding

JEL Classification: G21, G28, G32, K22, K23

Open PDF in Browser Download This Paper

Date posted: April 15, 2011 ; Last revised: January 21, 2014

Suggested Citation

Utset, Manuel A., Complex Financial Institutions and Systemic Risk. Georgia Law Review, Vol. 45, 2011; FSU College of Law, Public Law Research Paper No. 497; FSU College of Law, Law, Business & Economics Paper No. 11-5. Available at SSRN: http://ssrn.com/abstract=1810144

Contact Information

Manuel A. Utset (Contact Author)
Florida State University College of Law ( email )
425 W. Jefferson Street
Tallahassee, FL 32306
United States
(850) 644-7274 (Phone)
HOME PAGE: http://www.law.fsu.edu/faculty/mutset.html

Feedback to SSRN

Paper statistics
Abstract Views: 1,388
Downloads: 246
Download Rank: 91,853

© 2016 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollobot1 in 0.219 seconds