4 ms·

I don't see that working for the same reason having a mechanism to short stocks can't prevent stock crashes. Adding a positive feedback mechanism can't stabiliz

by smaddox 10y ago

I don't see that working for the same reason having a mechanism to short stocks can't prevent stock crashes. Adding a positive feedback mechanism can't stabilize a system (at least not in the real world, where you can't perfectly balance feedbacks against each other). If anything, they magnify instability. If we want to prevent the next crises, we need to address the underlying cause. I find Minsky's financial instability hypothesis quite poignant in this regard. I also highly recommend Steve Keen's work, which is heavily influenced by Minsky.

pash 10y ago
I'm not sure why you consider credit derivatives to be positive feedback mechanisms. They damp the losses the system otherwise suffers. The point of having the central bank play the role of CDS-issuer is that (a) a central bank alone has an infinite well of capital to draw on to sop up those losses, and (b) it ends up sopping up those losses anyway. So you might as well make the beneficiaries of the central bank's inevitable largesse pay for it, rather than pretending like it won't happen and then doling out get-out-of-bankruptcy-free cards when it does happen. Setting up a market for credit insurance that cannot fail would also help to reveal credit risks in a way that otherwise cannot be done. On Minsky—his thesis is that financial crises are inevitable. I've implied the same thing. Minsky proposed an antidote that relies on fiscal policy, which is politically determined and therefore unreliable (as we learned in the aftermath of the last crisis); I've proposed one that relies on what is essentially monetary policy wrapped in an automatic market mechanism.
eru 10y ago
Actually, shorting does help stabilize the stock market. First, the possibility of shorting gives people an incentive to dig up dirt early. Thus keeping management in line, and away from doing stuff that's too stupid. Second (and less important), once someone shorts, they are forced to buy later. Thus, giving the stock a guaranteed buyer.
- smaddox 10y ago
  Yes, on second thought, I was mistaken. Stock shorts do counter the instability of stock purchases. I suppose the real problem, then, is that stabilizing the stock system would require perfectly counterbalancing the two, which is infeasible in the real world. Stabilizing the system requires a financial damping friction. For the same reason, I didn't see how traditional CDS's could realistically stabilize the system. I only saw how they could only change the oscillation period. However, if the CDS's were issued by a central bank, which I now understand was the original author's suggestion, I do think I understand how they could play a fundamentally different role, i.e. the role of a financial damper. If the rate of issuance were properly controlled to be close to the critical damping condition, then I suppose the central bank could use such an instrument to stabilize the monetary system. It might be an interesting research project to determine how the instruments would need to be priced to provide the desired damping.

by smaddox 10y ago

pash 10y ago

I'm not sure why you consider credit derivatives to be positive feedback mechanisms. They damp the losses the system otherwise suffers. The point of having the central bank play the role of CDS-issuer is that (a) a central bank alone has an infinite well of capital to draw on to sop up those losses, and (b) it ends up sopping up those losses anyway. So you might as well make the beneficiaries of the central bank's inevitable largesse pay for it, rather than pretending like it won't happen and then doling out get-out-of-bankruptcy-free cards when it does happen. Setting up a market for credit insurance that cannot fail would also help to reveal credit risks in a way that otherwise cannot be done. On Minsky—his thesis is that financial crises are inevitable. I've implied the same thing. Minsky proposed an antidote that relies on fiscal policy, which is politically determined and therefore unreliable (as we learned in the aftermath of the last crisis); I've proposed one that relies on what is essentially monetary policy wrapped in an automatic market mechanism.

eru 10y ago

Actually, shorting does help stabilize the stock market. First, the possibility of shorting gives people an incentive to dig up dirt early. Thus keeping management in line, and away from doing stuff that's too stupid. Second (and less important), once someone shorts, they are forced to buy later. Thus, giving the stock a guaranteed buyer.

smaddox 10y ago
Yes, on second thought, I was mistaken. Stock shorts do counter the instability of stock purchases. I suppose the real problem, then, is that stabilizing the stock system would require perfectly counterbalancing the two, which is infeasible in the real world. Stabilizing the system requires a financial damping friction. For the same reason, I didn't see how traditional CDS's could realistically stabilize the system. I only saw how they could only change the oscillation period. However, if the CDS's were issued by a central bank, which I now understand was the original author's suggestion, I do think I understand how they could play a fundamentally different role, i.e. the role of a financial damper. If the rate of issuance were properly controlled to be close to the critical damping condition, then I suppose the central bank could use such an instrument to stabilize the monetary system. It might be an interesting research project to determine how the instruments would need to be priced to provide the desired damping.