Stephen Grenville
FAILURE OF FINANCIAL
MARKETS
Efficient Markets Hypothesis is not a good representation of how markets work in
practice
‘Animal spirits’ and endogenous risk ‘Animal spirits’ and endogenous risk produced correlated price collapse.
Risk management has seen this as a ‘once in a lifetime of the universe’ possibility. But it
EMH made regulation weak (light touch or soft touch) and regulators ineffective.
Failure of political support.
Basel II capital pillar compromised by rating Basel II capital pillar compromised by rating agency failures, and market discipline too pro-cyclical.
Macro-economy potentially fragile: prices not well anchored; markets not deep and resilient
Banks dominate financial sector
They are only lightly conglomerated
Company information is unreliable and legal system is questionable
is questionable
Administrative capacity is limited and institutional trust is low
Government is expected to help people and
Glass-Steagall banks, providing simple banking services. Others would like to return to G-S, but institutions are too conglomerated)
A ‘core’ safe sector with intensive intrusive supervision.
supervision.
A non-core sector with different degrees of regulation and strong disclosure
Oversight the two sectors with different supervisors, emphasizing different
government promise of protection.
Bank Indonesia for ‘core’ because of liquidity Bank Indonesia for ‘core’ because of liquidity knowledge, macro-orientation (for
counter-cyclical prudential measures) and crisis inputs
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Architecture and regulatory co-ordination Overall system stability
Crisis management
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“You should only invest in companies that
