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This is how the next financial crisis will spread around the world economy 

May 18, 2016

Satyajit Das, The Independent

A new economic crisis, which I believe we are on the brink of experiencing, will have similarities, and differences, to 2008. The problem of crowded trades – where market participants all have the same basic positions and strategies, and identical risk models – will be familiar.

The effect of new regulations, ironically designed to minimise the risk of a new crash, and a reduction in trading liquidity will create new problems. Extra capital, while welcome, does not alter the level of risk, but merely who bears it.

To recapitalise banks, regulators have approved risky hybrid securities, such as contingent capital and bail-in bonds. In the event of a systemic crisis, losses will be transmitted to insurance companies, pension funds and private investors; bailing them out may be politically necessary or expedient.

With simpler solutions proving politically difficult, attempts to reduce the risk in the chains of derivative contracts have focused on Central Counter Parties (CCPs), a theoretically bankruptcy-proof guarantor of transactions and collateral. CCPs have added complexity, creating new instability; CCP risk management is unproven under conditions of stress. Read more

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