Financial Haircuts

“The financial system…makes choices about haircuts. The haircuts in question are the amount of collateral a borrower places with the lender over and above the face value of borrowing. But collateral haircuts tend to behave rather differently to personal haircuts. They fall when the financial temperature is increasing and rise when the chill sets in. This strategy is explicitly  pro-cyclical. It will tend to result in financial markets being hot-headed in the summer and frozen-eared in the winter….This haircut cycle played an important causal role in the crisis…Hot heads make for bad decisions, frozen ears for uncomfortable ones. Financial markets have felt the effects of this change in the weather more dramatically than most. Suitably designed, macroprudential policy can help moderate those swings in temperature, thereby improving the health of the financial system. “

A.G. Haldane, BoE Executive Director, 1 August 2011

“In the good old days, haircuts were made in barbershops, not on financial markets. Until the late 80ies, economists writing about haircuts in the “American Economic Review” (AER) referred to real hairdressing. The first economist to use the term in the AER with regard to finance was Herbert Bear, a researcher with the Federal Reserve Bank of Chicago, in 1989. It took another 15 years and the default of Argentina until financial haircuts made it into “The Economist” for the first time, after all.”

The science of haircuts,

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