Risk of Financial Institutions.

• Position: Conferences

The NBER held a conference on "Risks of Financial Institutions" at the University of Chicago's Gleacher Center on April 24, Conference organizers Mark Carey, Federal Reserve Board of Governors, and Rene M. Stulz, NBER and Ohio State University, chose these papers for discussion:

Markus K. Brunnermeier, Princeton University and NBER, "Deciphering the 2007/8 Liquidity and Credit Crunch"

Discussant: Raghuram Rajan, University of Chicago and NBER

Atif Mian, University of Chicago and NBER, and Amir Sufi, University of Chicago, "The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis" (NBER Working Paper No. 13936)

Discussant: Stuart Gabriel, University of California, Los Angeles

Robert H. Litzenberger, Azimuth Asset Management, and David M. Modest, J.P. Morgan Chase, "Crisis and Non-Crisis Risk in Financial Markets: A Unified Approach to Risk Management"

Discussant: Philippe Jorion, University of California, Irvine

Philippe Jorion, and Gaiyan Zhang, University of Missouri, "Credit Contagion from Counterparty Risk"

Discussant: Richard Cantor, Moody's Investors Service

Amir Khandani, MIT, and Andrew Lo, MIT and NBER, "What Happened to the Quants in August 2007?"

Discussant: Kent Daniel, Northwestern University

Monica Billio and Loriana Pelizzon, University of Venice, and Mila Getmansky, University of Massachusetts, "Crises and Hedge Fund Risk"

Discussant: Tobias Adrian, Federal Reserve Bank of New York

Brunnermeier studies the underlying forces that drove adverse events in the financial markets in 2007 and 2008. He explains how new structured financial products, off-balance sheet vehicles, and the transformation from a classical banking model to an "originate and distribute model" led to a deterioration of lending standards and to a boom in house prices. He provides an event-log book about the current market turmoil and identifies various amplification mechanisms that explain how shocks to the financial system could cause such large dislocations. The first mechanism is attributable to borrowers' balance sheet effects involving liquidity spirals. When asset prices and market liquidity drop during times of crisis, funding requirements for financial institutions increase. This happens because the collateral value of the assets on borrowers' balance sheets erodes, and margins rise, or investors are unable to rollover their short-term liabilities. Higher margins force financial institutions to cut back on leverage...