1. A Macroeconomic Model of Endogenous Systemic Risk Taking D. Martinez-Miera and J. Suarez Discussion Rafal Raciborski DG ECFIN, European Commission Norges Bank, Oslo, 29 - 30 November 2012

2. Disclaimer The views expressed are the author’s alone and do not necessarily correspond to those of the European Commission.

3. Context It's been almost 5 years that the world has been in the financial and economic crisis… …with its causes still not yet fully understood… …but with a contribution of the financial sector generally unquestioned Most economists would agree the financial sector (banks in particular) may contribute to and perhaps generate systemic risk

4. This paper Discusses one particular channel via which systemic risk may originate in the banking sector – Idea most closely linked to the 'risk-shifting literature’ Embeds it into a general equilibrium model – May be disputed whether the systemic risk is truly endogenous; more on it later Solves nonlinearly to discuss optimal bank capital requirements

5. The model: general idea

6. The model: available projects 2 types of projects: 1.Less risky projects (in terms of its variance and its mean): idiosyncratic risk 2.More risky projects: risk perfectly correlated Higher variance of the risky projects to induce risk-shifting in the banks Correlation of risky projects=systemic risk Lower unconditional mean of the risky project probably makes things harder; conveys the idea of systemic risk being "bad"

7. The model: equilibrating force

8. Welfare Banks’ agency problem affects negatively the economy via 2 channels: – Static losses: picking inefficient projects – Dynamic losses: loss of bank equity (and, hence, lending capacity) in the event of a systemic shock Measurement: – All agents risk neutral; but GDP does not reflect welfare well – GDP (=added value) excludes capital losses – Does output (y=GDP+undepreciated K) correlate perfectly with welfare in your model?

9. Capital requirements

10. Results

11. Minor remarks (I)

12. Minor remarks (II) An issue with calibration? – You assume 35% depreciation in failed firms – For γ=7%, 70% of all projects are systemic – This gives 35%×70%=25% capital depreciation in the economy in the event of a systemic shock – Also the fall in GDP (30%) very large Develop the sensitivity analysis – “The choices for the values of […] ψ and φ are quite tentative.”

14. General equilibrium?

15. Take the black box as given What are the systemic projects? Allen&Gale (2000): oil shock – convincing, but with a limited application (Norway!) Your footnote 1: housing bust: – Is it systemic? What makes it so? – Was it (before 2007) considered risky? (The notion that “house prices never fall”) Even so: Is it plausible? Convince the reader! What happens in your model if you have 2 types of risky projects: identical payoffs, but projects of the 2 nd type independent

16. Bring your channel to the data “Systemic Banking Crises facts” (Boissay et al.): a)SBC’s are rare and deep b)SBC’s are closely linked to credit developments Ad. a) Your model can obviously match it, but: – by imposing exogenous prob. of a systemic crisis – endogenous risk correlation in recessions, Brunnermeier&Sannikov, 2011 (parsimony) Ad. b) Nothing to say about it – again, endogenous link (Boissay et al., 2012) – hard to make policy advice w/o a crucial channel Need to open up the black box

17. Interesting perverse effect? Your results sensitive to the exogenous probability of a systemic crisis – Benchmark: ε=0.03 One view: makes your results fragile Alternative view: innovations that make the economy safer (ε↘) make crises deeper… Worth exploring?