Abstract

http://ssrn.com/abstract=2001166
 


 



Credit Derivatives, Leverage, and Financial Regulation’s Missing Macroeconomic Dimension


Erik F. Gerding


University of Colorado Law School

February 8, 2012

Berkeley Business Law Journal, Vol. 8, 2011

Abstract:     
Of all OTC derivatives, credit derivatives pose particular concerns because of their ability to generate leverage that can increase liquidity - or the effective money supply - throughout the financial system. Credit derivatives and the leverage they create thus do much more than increase the fragility of financial institutions and increase counterparty risk. By increasing leverage and liquidity, credit derivatives can fuel rises in asset prices and even asset price bubbles. Rising asset prices can then mask mistakes in the pricing of credit derivatives and in assessments of overall leverage in the financial system. Furthermore, the use of credit derivatives by financial institutions can contribute to a cycle of leveraging and deleveraging in the economy.

This Article argues for viewing many of the policy responses to credit derivatives, such as requirements that these derivatives be exchange traded, centrally cleared, or otherwise subject to collateral or 'margin' requirements, in a second, macroeconomic dimension. These rules have the potential to change – or at least better measure – the amount of liquidity and the supply of credit in financial markets and in the 'real' economy. By examining credit derivatives, this Article illustrates the need to see a wide array of financial regulations in a macroeconomic context.

Understanding credit derivatives’ macroeconomic effects has implications for macroprudential regulatory design. First, regulations that address financial institution leverage offer central bankers new tools to dampen inflation in asset markets and to fight potential asset price bubbles. Second, even if these regulations are not used primarily as monetary or macroeconomic levers, changes in these regulations, including changes in the effectiveness of these regulations due to regulatory arbitrage, can have profound macroeconomic effects. Third, the macroeconomic dimension of credit derivative regulation and other financial regulation argues for greater coordination between prudential regulation and macroeconomic policy.

Number of Pages in PDF File: 45

Accepted Paper Series





Download This Paper

Date posted: February 8, 2012  

Suggested Citation

Gerding, Erik F., Credit Derivatives, Leverage, and Financial Regulation’s Missing Macroeconomic Dimension (February 8, 2012). Berkeley Business Law Journal, Vol. 8, 2011. Available at SSRN: http://ssrn.com/abstract=2001166

Contact Information

Erik F. Gerding (Contact Author)
University of Colorado Law School ( email )
401 UCB
Boulder, CO 80309
United States
303 492 4899 (Phone)

Feedback to SSRN


Paper statistics
Abstract Views: 2,725
Downloads: 399
Download Rank: 42,183

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo1 in 0.484 seconds