Originally Posted by Yoda
What applicable regulations were not applied?
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As complicated as the effects and implications of all this may be, the core of the matter is startlingly straightforward: the banks wouldn't issue high-risk loans. The government compelled them to with serious penalties. The banks issued the loans to comply, and many people defaulted on their mortgages. Does anyone here dispute this chain of logic? Does anyone dispute that the paramount fact when discussing mortgage failure is the criteria used to determine who qualifies for mortgages?
I've finally found a seemingly even-handed article that's helped clarify my thoughts on all this a bit.... if you'll indulge me...
A short history of modern finance - The Economist - Oct 16th 2008
(NB The Economist is actually a stalwart defender of free trade and free markets)
As the title suggests, it's a bit of a slog, but I think I could summarise some of it's assertions & conclusions like this:
We wouldn't have been any better off if politicians had been steering the ship (poor regulation & comparable complacency):- They insisted on the problematic high-risk loans (especially in the US); were more than happy to rake in the benefits of the credit-based 'liquidity' that abounded (getting as complacent as anyone during the 'predictable' calm of 'The Great Moderation'); and pushed the banks a step too far with the poorly-targeted regulations of the Basel accord(s).
Deregulation gave the vulnerable banks enough rope to hang themselves with (opacity & greed):- Governments put the banks on a teetering chair when they regulated them into dangerously 'high leveraged' positions, but a string of deregulation events had created dubious 'risk trading' packages (notably CDSs & 'Securitisation' practices) that were too tempting for them and others to pass up, and were desperately in need of 'transparency'...
What regulation can (and should) have done:- Regulating 'watchdogs' have concentrated on "making sure that deals were well documented or settled through a central clearing house". But that is "something yet to be achieved for CDSs". The takeaway lesson being: "Bankers and traders were always one step ahead of the regulators."
There's a whole lot more in there of course, and I've probably skewed and muddied somewhat in my attempt to navigate the jargon, and my own prejudices.
It seems fair to say, though, that various financial entities were using these 'risk trading' techniques regardless of the poor mortgage & risk regulations implicated above - and that said packages were an accident waiting to happen.
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DISCUSSION
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Markets cover more ground when they're freewheeling, that much is clear. But regulation still seems to be required in certain 'paternal' roles, to stop them charging
en masse into a wall.
- The key one the above article seems to suggest is insistence on 'transparency' - which makes a certain layman's sense (only cheaters/'free riders' have got something to hide etc)
- Another one I've picked up on my travels through the economic tittle-tattle is the idea of implementing a degree of risk/leverage limitation - although of course, execution is all, and it can certainly be done badly (as displayed by Basel 'et al' ).
On this last point I'd just highlight a few voices from the sidelines: (There are plenty of shrill ones out there during these doom-mongering times, but
these guys {pay per view}, for example, seem to have the market's best interests at heart, above any particular partisan creed. And that biases me towards listening to them scream
)
The article looks at some alternative risk-assessment models (which you can snort or cheer at, considering it's risk-assessment that has partially got us into this mess
). They're trying to correct past failures and inadequacies, are generally disparaging of a prominent school of thought called 'Equilibrium theory', and are mainly examining 'flocking' behaviours in markets to explain 'busts'. One group in particular caught my eye with their focus on leverage:
Increasing levels of credit create stronger links between market players, heightening the chance that the failure of one can put an unsustainable burden on others, triggering further failures. In the simulations, once the level of leverage passes a certain threshold, it becomes overwhelmingly likely that a single chance failure will send waves of trouble through the entire market. Avoiding future crises will mean identifying where the real-world market's "freezing point" is - and keeping levels of leverage low enough to steer clear of it.
There are guys 'further afield' like
Nassim Taleb (pdf) who've been telling us that the 'black swans' of the market are inherently unpredictable, and optimists like
this fellow, who point out the social benefits of booms and busts. But right now I'd seize on the idea that we need to keep the market free-flowing, but make sure our risk-assessment techniques are robust, and not leading us over a cliff as we try to eat pie in the sky
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The two regulatory tasks I mention above are clearly a huge ask, especially in the face of the impish creativity and deviousness of the assorted 'bankers' out there (scurrying over the variously-levelled playing field). I get the feeling they've been neglected somewhat though. Taking on the big boys & looking out for long-term stability are two things that rarely sit happily alongside political dreams