Quote:
Originally Posted by ERD50
Even if you come up with a good set of "white lines" for CDS derivatives, that leaves an infinite number of possibilities for other scams. I've said it before, the scammers can react faster than the law.
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But the major problem with CDS and even sub-prime mortgage exposure didn't have much to do with any "scams" or "scammers". While this is more clear in CDS it is still true for both.
Part of the problem was a philosophy that said "profit seeking enterprises are
always best suited to look after their own interests." So by that rationale financial institutions were given free reign to do pretty much whatever they wanted because the
philosophy said that they'd be better at it then anyone else. As it turned out, though, these profit seeking enterprises were generally more concerned with garnering profit for themselves
today and a bit less concerned about the longer-term impact of either excessive exposures to sub-prime or to their CDS counterparties. Their failure to self regulate is central to the problem we're facing today.
Two examples are illustrative:
1) Broker dealers actively lobbied to prevent a central counterparty clearing house for CDS contracts. Making markets in non-transparent, over-the-counter derivatives was so lucrative that banks were willing to accept all of the counterparty credit risk for these trades. But instead of self regulating those exposures as the "
philosophy" assumed they would, the banks instead gorged on the short-term profits. And with each afraid to concede market share to another, they raced to the bottom creating huge systemic risks in their wake. The result was a structure that rendered almost any large commercial bank, investment bank, or insurance company "too big to fail".
So as it turns out, the unwillingnes of financial institutions to regulate themselves combined with a misplaced faith that they would, created a situation requiring much greater government intervention and regulation than would have been true otherwise. Congratulations.
2) Commercial banks created "Structured Investment Vehicles" (the infamous "SIVs", otherwise knows as off balance sheet financings) to circumvent capital adequacy requirements so they could incur MORE exposure to sub-prime mortgages. This is clearly a case of financial institutions NOT self-regulating, but rather actively seeking ways to assume even more risk then was prudent. It is also another nail in the coffin of the "Fannie & Freddie caused it all" argument. Had the commercial banks not attempted to circumvent their lending regulations, or had regulators consolidated the SIV structures, the impact of the sub-prime mess would have been less.
The moral of this particular story is that financial institutions can not be expected to completely self regulate. We tried that and it nearly caused the full scale collapse of the free-market system. So now we know that tighter governmental limits on leverage and counterparty exposure for a wide range of financial institutions are clearly necessary to prevent this from happening again.
I tend to agree with Independent's thought that a larger number of firms need to be brought under the regulatory umbrella and subject to capital requirements but that list is pretty extensive. For starters it includes (in addition to commercial banks) investment banks, insurance companies, the financing arms of industrials (GMAC, GE Finance, etc.), hedge funds, and potentially pension & mutual funds. The shadow banking system is large.