Yale economist and SFI External Professor John Geanakoplos argues in a paper just released by the Federal Reserve Bank of New York that in moments of financial crisis, central banks should lend at more generous terms than the market.
In the paper, Geanakoplos discusses his influential theory on collateral rates and the “leverage cycle,” arguing that the recent crisis reflected the shift in leverage from a state of excessively loose, small-collateral demands to one of an excessive reversal in which lenders respond to a marketwide shock by making very high collateral, or "haircut," demands from debtors. To break this self-reinforcing cycle, central banks should focus on lending with lower collateral costs than those prevailing in the market during a crisis, he wrote.
His paper is one of six related papers published by financial experts August 12, 2010, as part of a special issue of the Bank’s Economic Policy Review series themed "Central Bank Liquidity Tools and Perspectives on Regulatory Reform."
See also: Economic Policy Review, August 12, 2010
See also: The paper (pdf) by John Geanakoplos: “Solving the Present Crisis and Managing the Leverage Cycle”
See also: Wall Street Journal blogs