Financial Markets Conference: Financial Innovation and Crises - May 11-13, 2009

Monday, May 11, 2009

Welcome and opening remarks
Dave Altig, Senior Vice President and Research Director, Federal Reserve Bank of Atlanta

Paper I—"Tranching and Rating"

Presenter: Michael Brennan, Professor Emeritus, UCLA Anderson School of Management [Paper PDF logo | Presentation PPT logo]
Discussant: Mark Flannery, Eminent Scholar, University of Florida [Presentation PPT logo]
Chair: Gerald Dwyer, Director of Center of Financial Innovation & Stability, Federal Reserve Bank of Atlanta

Paper II—"Market Liquidity and Funding Liquidity"

Presenter: Markus Brunnermeier, Professor of Economics, Princeton University [Paper PDF logo | Presentation PDF logo | Additional paper PDF logo]
Discussant: Christian Gilles, Managing Director, JPMorgan Chase
Chair: Mark Jensen, Financial Economist and Associate Policy Adviser, Federal Reserve Bank of Atlanta

Dinner and keynote speaker
"The Supervisory Capital Assessment Program" links off-site
Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System

Tuesday, May 12, 2009

Welcome and opening remarks
Dennis Lockhart, President and CEO, Federal Reserve Bank of Atlanta

Policy Session I—Measuring and Managing Risk in Innovative Financial Instruments
This paper will discuss the various tools and strategies for measuring and managing risk in innovative financial instruments. Specific attention will be paid to pricing of the instruments, the role of credit ratings, and liquidity risk.

Innovative financial instruments and products pose several challenges for measuring and managing risk. Claims of improper valuation and inadequate risk management have been at the center of the recent credit market turmoil and seem to be tied to the innovative nature of the MBS market and securitization. As financial engineering continues, market participants and regulators will again face the need to update their own pricing models and risk management techniques. This session will survey state-of-the-art knowledge and practices in these areas and offer perspectives on future innovation in risk management. Specifically, participants will discuss the tools available for valuation and risk management and how to evaluate their applicability, the role of rating agencies in managing risk, and the particular challenge of modeling and managing liquidity risk.

Paper presenter: Stuart Turnbull, Professor of Finance, University of Houston [Paper PDF logo | Presentation PPT logo]
Moderator: Eric Rosengren, President and CEO, Federal Reserve Bank of Boston
Discussant: Charles Smithson, Managing Partner, Rutter Associates [Presentation PPT logo]
Discussant: David Rowe, Group Executive Vice President, SunGard [Presentation PPT logo]

Policy Session II—Standardization and Clearinghouses as Tools for Lessening Systemic Risk
This panel discussion will address the ways instrument standardization and the existence of clearinghouses lessen systemic risk. In particular, participants will take a historical look at futures/options markets and current markets like CDSs.

Innovative financial instruments often begin as idiosyncratic OTC products, traded in obscure, two-way transactions. This feature of the market points up the central role of counterparty risk, the resulting murkiness of financial linkages, and concerns regarding systemic risk exposure. Standard contract terms and/or underlying assets, along with the establishment of a clearinghouse, could lessen systemic risk by increasing liquidity and netting counterparty risk. But several specific questions remain: Would such moves be beneficial in the structured finance market and other innovative markets to come? Do financial market participants demand specialized contracts, or are these a result of the natural diffusion and progression of innovation? Would the expectation of standardization lessen innovation? Would a clearinghouse succeed, and how should such entities be formed and regulated in non-equity markets? Would trade reporting create enough transparency to lessen systemic risk, or would it require regulation via exchange-traded instruments?

Moderator: Edward Kane, Professor of Finance, Boston College [Presentation PPT logo]
Panelist: Eric Beinstein, Managing Director, JPMorgan Chase
Panelist: Charles Vice, President and Chief Operating Officer, ICE [Presentation PPT logo]
Panelist: Craig Pirrong, Professor of Finance, University of Houston [Presentation PPT logo]

Dinner and keynote speaker
"Systemic Risk and the Role of Government" PDF logo
John Taylor, Professor of Economics, Stanford University

Wednesday, May 13, 2009
Policy Session III—International Exposure to U.S.-Centered Credit Market Turmoil
This paper will address the international transmission of financial crises and the challenges of domestic and internationally coordinated regulatory responses.

The underlying assets that triggered the recent crisis were U.S. subprime mortgages. The first alarm bells sounded in Germany. The United Kingdom suffered a bank run, while, until recently, Asia and emerging markets have remained largely unscathed. There are lessons to be learned when liquidity and solvency risks associated with structured investments pervade global financial markets. In addition to illuminating these lessons, this presentation will consider the particular issues raised by the (potential) failure of large banks with cross-border operations. These concerns arise in almost every part of the world that is either home or host to banks with large cross-border operations.

Paper presenter: Stijn Claessens, Assistant Director, International Monetary Fund [ Paper PDF logo | Presentation PPT logo]
Moderator: Gay Huey Evans, Vice Chairman of Investment Banking and Investment Management, Barclays Capital
Discussant: Vincent Reinhart, Resident Scholar, American Enterprise Institute [Presentation PPT logo]
Discussant: Alistair Milne, Reader in Banking, Cass Business School [Handout PDF logo | Handout 2 PPT logo]

Policy Session IV—The Role of Banks in Financial Markets: Policy and Practice
This session will explore the current and future role of banks in financial markets. In particular, how will the business models of banks change, and how will they evolve with respect to other financial market participants such as hedge funds?

Commercial banks and investment banks were central to the credit turmoil as originators of structured investment products, as major counterparties in various credit instruments including U.S. Treasuries and repo transactions, and as prime brokers to hedge funds. In the face of an estimated $400 billion of subprime losses, many have questioned how the business models of banks will change. This session will explore the role of banks in financial marketsin terms of the services they provide as well as their structure and integration with other financial market participants.

Paper presenter: Gary Gorton, Professor of Finance, Yale School of Management [Paper PDF logo | Presentation PPT logo]
Moderator: Charles Plosser, President & CEO, Federal Reserve Bank of Philadelphia
Discussant: H. Rodgin Cohen, Chairman, Sullivan & Cromwell LLP
Discussant: David Kotok, Chairman and CIO, Cumberland Advisors [Presentation PPT logo]

Luncheon and closing remarks
Dennis Lockhart, President and CEO, Federal Reserve Bank of Atlanta
Adjourn conference