Solving the Present Crisis and Managing the Leverage Cycle

49 Pages Posted: 21 Jan 2010  

John Geanakoplos

Yale University - Cowles Foundation

Multiple version iconThere are 2 versions of this paper

Date Written: January 20, 2010

Abstract

The present crisis is the bottom of a recurring problem that I call the leverage cycle, in which leverage gradually rises too high then suddenly falls much too low. The government must manage the leverage cycle in normal times by monitoring and regulating leverage to keep it from getting too high. In the crisis stage the government must stem the scary bad news that brought on the crisis, which often will entail coordinated write downs of principal; it must restore sane leverage by going around the banks and lending at lower collateral rates (not lower interest rates), and when necessary it must inject optimistic capital into firms and markets than cannot be allowed to fail. Economists and the Fed have for too long focused on interest rates and ignored collateral.

Keywords: Leverage, Collateral, Margins, Leverage cycle, Externality, Principal

JEL Classification: E3, E32, G01, G12

Suggested Citation

Geanakoplos, John, Solving the Present Crisis and Managing the Leverage Cycle (January 20, 2010). Cowles Foundation Discussion Paper No. 1751. Available at SSRN: https://ssrn.com/abstract=1539488 or http://dx.doi.org/10.2139/ssrn.1539488

John D Geanakoplos (Contact Author)

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3397 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://cowles.econ.yale.edu/P/au/d_gean.htm

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