Rethinking Capital Regulation

Recent estimates suggest that u.S. banks and investment banks may lose up to $250 billion from their exposure to residential mortgage securities. the resulting depletion of capital has led to unprecedented disruptions in the market for interbank funds and to sharp contractions in credit supply, with adverse consequences for the larger economy. a number of questions arise immediately. Why were banks so vulnerable to problems in the mortgage market? What does this vulnerability say about the effectiveness of current regulation? how should regulatory objectives and actual regulation change to minimize the risks of future crises? these are the questions we focus on in this paper.

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