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Restoring Confidence In The Financial System: See-through leverage: a powerful new tool for revealing and managing risk

Book Description

'Restoring Confidence In The Financial System' is a ground-breaking book in which a top mathematician, who is also one of the City of London's most experienced traders, and an experienced City banker explore how confidence in the global financial system was destroyed by the current banking crisis. Drawing on his firsthand experience of steering the trading floor at a major European bank, Sean Tully, together with Richard Bassett, analyses the steps that led up to the crisis and pinpoint precisely one of the main causes of the lending bubble with whose consequences we are all now living. The authors explain the intricacies of the regulatory framework of Basel I and Basel II, the two landmark events in banking regulation which inadvertently laid the foundation for the current crisis. The authors then show how a radical and new but easily understood measure of risk, revealed here for the first time, can prevent another such bubble from ever happening again. This new measure, called see-through leverage or STL, can be used to restore faith in the financial system by allowing a rapid means of differentiating between potentially toxic and healthy 'AAA'-rated securities. Armed with STL, investors, rating agencies and regulators alike can cut through the complexity of economic modeling to the nub of the problem: leverage. 'Restoring Confidence In The Financial System' is a vital book for the international business community. In a globally interconnected world, no one can claim to be untouched by the crisis. How could bankers have got their sums so wrong? How could regulators and politicians have failed to see the storm coming? Above all, how can confidence be restored to get the wheels of the global finance machine working again? This book has the solution.

Table of Contents

  1. Cover
  2. Copyright
  3. Acknowledgements
  4. Preface
  5. Introduction
  6. 1: Brave New World
    1. Chapter summary
    2. Big Bang: the City reborn
    3. Conservatives on risk
    4. The rise of the machines: new financial products
    5. The crash of 1929 and investment trusts
    6. The Crash of 1987 and the dangers of leverage
    7. The Japanese financial crisis
    8. Further financial crises
    9. Shadow banking
    10. Leverage: hero or zero?
  7. 2: The Unintended Consequences Of Basel I And Basel II
    1. Chapter summary
    2. Basel I
    3. The 1996 Market Risk Amendment: hiding risks using Gaussian lenses
    4. Basel II: leverage soars
    5. Modern portfolio theory (MPT)
  8. 3: Rating Agencies And The Shadow Banking System
    1. Chapter summary
    2. Rating agencies and the use of their ratings
    3. The shadow banking system
    4. ABCP: short term, low risk and high liquidity
    5. Structured investment vehicles (SIVs)
    6. Collateralised debt obligations (CDOs)
    7. Enter the monoline insurers
  9. 4: How The Current System Failed And The Need For See-Through Leverage (STL)
    1. Chapter summary
    2. Confidence destroyed
    3. Risk weighting under Basel
    4. Maximising a bank’s return on capital (ROC): growth of off-balance-sheet securitisation structures
    5. Basel II: using credit ratings as a measure of risk
    6. CDOs: splicing and reconstituting assets to reduce required capital
    7. The result: an increase in systemic leverage
    8. The family of STL risk indices
  10. 5: How STL Should Be Used In Practice By Investors, Regulators And Rating Agencies
    1. Chapter summary
    2. STL(X) is really see-through leverage!
    3. Examples of securitisations
  11. 6: Towards A Basel III
    1. Chapter summary
    2. Restoring confidence
    3. Exploring extreme confidence and extreme leverage
    4. The flaws of Basel II
    5. The flaw in VaR-based capital rules
    6. The flaws of money market regulations
    7. What Basel III might look like
    8. The response of the CGFS to the crisis
    9. Conclusion: Towards Basel III
  12. Glossary
  13. Bibliography