Redefining and Containing Systemic Risk‪.‬

Government officials everywhere acknowledge a responsibility for overseeing systemic risk. But before one can begin to control a target variable (even something as straightforward as the temperature of a room), one must define the variable comprehensively and fashion from this definition one or more verifiable metrics for monitoring the target. Official definitions of systemic risk fail both of these tests. Official definitions focus on a perceived potential for substantial spillovers of institutional defaults across important firms in the financial sector and from this sector to the real economy. These definitions are not comprehensive because they exclude a systemic phenomenon: that substantial spillovers of actual defaults have remained largely and predictably hypothetical.