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Toward a Run-Free Financial System
Report

Toward a Run-Free Financial System

John H. Cochrane
Chicago Booth, 2014
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Editorial Rating

7

Qualities

  • Analytical
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Recommendation

In 2008, runs on financial institutions had a devastating impact on the world’s economy. University of Chicago professor John H. Cochrane says runs were the major culprits behind the crisis and believes the same thing could easily happen again in today’s environment. He explains why overregulation will not work, and advocates restructuring the financial system through measures such as shoring up bank equity and avoiding run-prone assets. Cochrane effectively pokes holes in the current American financial and regulatory systems. His proposals, many of which echo those under consideration in Europe, may make sense for the United States as well. getAbstract recommends this report to financial executives, analysts and policy makers who might be intrigued by this line of thinking.

Summary

Running on Empty

The downfall of the financial system in 2008 boiled down to runs on assets and financial institutions. From the swift devaluation of asset-backed securities to the plunge in housing prices, runs by panicked investors paved the way toward recession. Subsequent attempts to address the problem of institutional and systemic runs through greater regulation aren’t going to be as effective as authorities hope.

Given that reality, it makes sense that any changes that are intended to avoid another financial crisis should focus on ways to eliminate such runs. Measures could include dramatically shoring up bank equity, avoiding run-prone assets, and backing money market funds or overnight debt with safe, predictable short-term Treasury securities. Pigouvian taxes, commonly used to cover the costs of externalities such as environmental pollution, would also work well in finance: Banks and other intermediaries would pay such taxes on the run-prone short-term debt they issue.

Despite efforts to avert another financial crisis, current policies do little to address the problem of runs on the financial system, and in some cases, they inadvertently encourage ...

About the Author

John H. Cochrane is a finance professor at the University of Chicago Booth School of Business.

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