Panel
Systemic Risk: Inevitable or Preventable?
Milken InstituteScarlet Fu, Dimitri Demekas, Fiona Frick, Michael Piwowar, Paul Sheard, John C. Williams
- Definition of Systemic Risk: The panel defines systemic risk as the threat of severe financial sector disruption causing significant repercussions for the real economy, often driven by liquidity evaporation or government bailouts.
- Primary Sources of Risk (Consensus & Divergence):
- Dimitri Demekis (IMF): Identifies disorderly adjustment in China or emerging markets as the current primary threat.
- Fiona Frick (Unigestion): Highlights negative-yielding government bonds in Europe and Japan (70–75% of such bonds) and liquidity mismatches in asset management as key risks.
- Michael Puar (SEC): Argues the U.S. Federal Government and Federal Reserve are the biggest sources, citing fiscal policy and near-zero interest rates driving "reaching for yield" and asset bubbles.
- Paul Sheard (S&P Global): Points to the structural conundrum of the financial system creating artificial liquidity from illiquid real assets, with Brexit and a China hard landing as immediate shocks.
- John Williams (San Francisco Fed): Emphasizes that high asset valuations relative to U.S. Treasuries and sovereign bonds pose risks if interest rates rise.
- Global Economic Outlook:
- New Normal: John Williams argues the global equilibrium interest rate is structurally lower than 25 years ago due to demographics and productivity, necessitating a "new normal" of lower rates rather than policy failure.
- Japan Lessons: Paul Sheard characterizes Japan's 1990s "forbearance" (covering up bank losses) as a cautionary tale, contrasting it with current aggressive monetary easing and the need for better fiscal-monetary coordination.
- China Outlook: Paul Sheard notes China faces a credit-fueled boom similar to Japan's pre-bubble era; he advises against hiding problems to avoid "zombie firms," a view echoed by Fiona Frick who avoids direct exposure to opaque Chinese corporate debt.
- Regulatory Framework & Stability:
- Effectiveness of Dodd-Frank: The panel agrees higher capital requirements, stress tests (CCAR), and living wills have made banks more resilient, effectively transforming them into "defensive utility-like" entities.
- Interconnectedness: Regulators note that systemic risk now stems from linkages between sectors (banks, insurance, money markets) rather than isolated failures; the 2008 crisis involved AIG and Lehman primarily through their banking creditors.
- Ring Fencing: While ring-fencing retail banking is seen as a potential future step (and already in the UK), John Williams warns that in a global system, cross-border regulatory coordination remains the unresolved challenge.
- Too Big to Fail: The panel shifts focus from "too big to fail" to "too interconnected" or "too complex to fail," noting that Central Counterparties (CCPs) created by Dodd-Frank may have created a new class of "too big to fail" institutions by concentrating risk.
- Emerging Risks & Liquidity:
- ETFs: Michael Puar notes ETFs in illiquid asset classes create a "false sense of liquidity," prompting the SEC to propose new liquidity risk management rules for investment companies.
- Safe Asset Demand: John Williams warns of a persistent, insatiable global demand for "money-like" assets, which could drive the next cycle of financial engineering and bubbles (e.g., new AAA securities).
- Uncertainty vs. Risk: Michael Puar and Paul Sheard argue that regulators cannot predict specific "unknown unknowns" and should focus on building system resilience and transparency rather than attempting to forecast specific shocks.
- Key Quotes & Forward-Looking Statements:
- Fiona Frick: "Systemic risk is a bit like the Greek monster Hydra... you cut the head and the head comes back."
- Michael Puar: "The real challenge is... figuring out how to deal with uncertainty, not risk."
- John Williams: "The insatiable demand for money-like assets... is still there and is just waiting for the next clever financial engineer to come up with a new asset class."
- Three Wishes for Risk Minimization:
- Dimitri Demekis: Tackle "too big to fail" and maintain political will to address crisis issues as memories fade.
- Fiona Frick: Create a global "board" to visualize liquidity flows across regulated and unregulated markets to improve transparency.
- Paul Sheard: Prevent society from forgetting past lessons to curb "irrational exuberance."
- Michael Puar: Achieve better regulatory transparency to ensure policymakers do not make decisions "fumbling in the dark."
- John Williams: Instill "courage" in policymakers to act decisively rather than waiting for problems to resolve themselves.
- Fiscal-Monetary Coordination:
- The panel consistently notes that in the post-crisis era, reliance has been too heavily on monetary policy with insufficient fiscal support, particularly in the Eurozone.
- John Williams highlights that while business cycles are uncoordinated globally, central banks must still account for cross-border spillovers, creating a "codependency" in policy responses.