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Wednesday 05 May 2010 | Financial Crisis feed
Advertisement Website of the Telegraph Media Group with breaking news, sport, business, latest UK and world news. Content from the Daily Telegraph and Sunday Telegraph newspapers and video from Telegraph TV. Enhanced by Google Home News Election 2010 Sport Finance Lifestyle Comment Travel Culture Fashion Jobs Dating Subscriber Offers News by Sector Comment Personal Finance Markets Economics Your Business Business Club Blogs Finance Video Fund Game Home Finance Finance Topics Financial Crisis Nouriel Roubini: forget sub-prime mortgages. It's the sub-prime financial system we need to fix Here's an exclusive extract from a new book by Nouriel Roubini and Stephen Mihm.Published: 8:01AM BST 04 May 2010
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Nouriel Roubini was one of the few to anticipate the scale of the crisis Photo: Getty ImagesFor the past half century, academic economists, Wall Street traders, and everyone in between have been led astray by fairy tales about the wonders of unregulated markets and the limitless benefits of financial innovation. The crisis dealt a body blow to that belief system, but nothing has replaced it.
Thatâ??s all too evident in the timid reform proposals currently being considered in the United States and other advanced economies. Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel. Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.
Related Articles Roubini warns US banking system effectively insolvent UK wins concessions on EU rules Dunfermline / Nationwide: How are you affected by the building society merger? Cheap fixed-rate mortgages disappear as banks boost profits Banks accused of exploiting mortgage customers as profit margins rise Budget 2009: Who would make a better Chancellor?Throughout most of 2009, Goldman Sachs chief executive Lloyd Blankfein repeatedly tried to quash calls for sweeping regulation of the financial system. In speeches and in testimony before Congress, he begged his listeners to keep financial innovation alive and â??resist a response that is solely designed to protect us against the 100-year stormâ?.
Thatâ??s ridiculous. What weâ??ve experienced wasnâ??t some crazy once-in-a-century event. Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis. Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again. The crisis was less a function of sub-prime mortgages than of a sub-prime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.
The road to recovery will be a long one. For starters, traders and bankers must be compensated in a way that brings their interests in alignment with those of shareholders. That doesnâ??t necessarily mean less compensation, even if thatâ??s desirable for other reasons; it merely means that employees of financial firms should be paid in ways that encourage them to look out for the long-term interests of the firms.
Securitisation must be overhauled as well. Simplistic solutions, such as asking banks to retain some of the risk, wonâ??t be enough; far more radical reforms will be necessary. Securitisation must have far greater transparency and standardisation, and the products of the securitisation pipeline must be heavily regulated. Most important of all, the loans going into the securitisation pipeline must
Published: 8:01AM BST 04 May 2010
Comments 14 | Comment on this article
For the past half century, academic economists, Wall Street traders, and everyone in between have been led astray by fairy tales about the wonders of unregulated markets and the limitless benefits of financial innovation. The crisis dealt a body blow to that belief system, but nothing has replaced it.
Thatâ??s all too evident in the timid reform proposals currently being considered in the United States and other advanced economies. Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel. Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.
Throughout most of 2009, Goldman Sachs chief executive Lloyd Blankfein repeatedly tried to quash calls for sweeping regulation of the financial system. In speeches and in testimony before Congress, he begged his listeners to keep financial innovation alive and â??resist a response that is solely designed to protect us against the 100-year stormâ?.
Thatâ??s ridiculous. What weâ??ve experienced wasnâ??t some crazy once-in-a-century event. Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis. Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again. The crisis was less a function of sub-prime mortgages than of a sub-prime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.
The road to recovery will be a long one. For starters, traders and bankers must be compensated in a way that brings their interests in alignment with those of shareholders. That doesnâ??t necessarily mean less compensation, even if thatâ??s desirable for other reasons; it merely means that employees of financial firms should be paid in ways that encourage them to look out for the long-term interests of the firms.
Securitisation must be overhauled as well. Simplistic solutions, such as asking banks to retain some of the risk, wonâ??t be enough; far more radical reforms will be necessary. Securitisation must have far greater transparency and standardisation, and the products of the securitisation pipeline must be heavily regulated. Most important of all, the loans going into the securitisation pipeline must be subject to far greater scrutiny. The mortgages and other loans must be of high quality, or if not, they must be very clearly identified as less than prime and therefore risky.
Some people believe that securitisation should be abolished. Thatâ??s short-sighted: properly reformed, securitisation can be a valuable tool that reduces, rather than exacerbates, systemic risk. But in order for it to work, it must operate in a far more transparent and standardised fashion than it does now.
Absent this shift, accurately pricing these securities, much less reviving the market for securitisation, is next to impossible. What we need are reforms that deliver the peace of mind that the Food and Drug Administration (FDA) did when it was created.
Letâ??s begin with standardisation. At the present time, there is little standardisation in the way asset-backed securities are put together. The â??deal structuresâ? (the fine print) can vary greatly from offering to offering. Monthly reports on deals (â??monthly service performance reportsâ?) also vary greatly in level of detail provided. This information should be standardised and pooled in one place.
It could be done through private channels or, better, under the auspices of the federal government. For example, the Securities and Exchange Commission (SEC) could require anyone issuing asset-backed securities to disclose a range of standard information on everything from the assets or original loans to the amounts paid to the individuals or institutions that originated the security.
Precisely how this information is standardised doesnâ??t matter, so long as it is done: we must have some way to compare these different kinds of securities so they can be accurately priced. At the present time, we are stymied by a serious apples-and-oranges problem: the absence of standardisation makes comparing them with any accuracy impossible. Put differently, the current system gives us no way to quantify risk; thereâ??s far too much uncertainty.
Standardisation, once achieved, would inevitably create more liquid and transparent markets for these securities. Thatâ??s well and good, but a few caveats also come to mind. First, bringing some transparency to plain-vanilla asset-backed securities is relatively easy; itâ??s more difficult to do so with preposterously complicated securities like Collateralised Debt Obligations (CDOs), much less chimerical creations like the CDO2 and the CDO3.
Think for a moment about what goes into a typical CDO. Start with a thousand different individual loans, be they commercial mortgages, residential mortgages, auto loans, credit card receivables, small business loans, student loans, or corporate loans. Package them together into an asset-backed security (ABS). Take that ABS and combine it with 99 other ABSs so that you have 100 of them. Thatâ??s your CDO. Now take that CDO and combine it with another 99 different CDOs, each of which has its own unique mix of ABSs and underlying assets. Do the maths: in theory, the purchaser of this CDO is supposed to somehow get a handle on the health of 10m underlying loans. Is that going to happen? Of course not.
For that reason, securities like CDOs â?? which now go by the nickname of Chernobyl Death Obligations â?? must be heavily regulated if not banned.
In their present incarnation, they are too estranged from the assets that give them value and are next to impossible to standardise. Thanks in large part to their individual complexity, they donâ??t transfer risk so much as mask it under the cover of esoteric and ultimately misleading risk-management strategies.
In fact, the curious career of CDOs and other toxic securities brings to mind another, less celebrated acronym: GIGO, or â??garbage in, garbage outâ?.
Or to use a sausage-making metaphor: if you put rat meat and trichinosis-laced pig parts into your sausage, then combine it with lots of other kinds of sausage (each filled with equally nasty stuff), you havenâ??t solved the problem; you still have some pretty sickening sausage.
The most important angle of securitisation reform, then, is the quality of the ingredients. In the end, the problem with securitisation is less that the ingredients were sliced and diced beyond recognition than that much of what went into these securities was never very good in the first place.
Put differently, the problem with originate-and-distribute lies less with the distribution than with the origination. What matters most is the creditworthiness of the loans issued in the first place.
Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis. So-called over-the-counter derivatives â?? better described as under-the-table â?? must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted. Moreover, the regulation of derivatives should be consolidated under a single regulator.
The ratings agencies must also be collared and forced to change their business model. That they now derive their revenue from the firms they rate has created a massive conflict of interests. Investors should be paying for ratings on debt, not the institutions that issue the debt. Nor should the rating agencies be permitted to sell â??consultingâ? services on the side to issuers of debt; that creates another conflict of interests. Finally, the business of rating debt should be thrown open to far more competition. At the present time, a handful of firms have far too much power.
Even more radical reforms must be implemented as well. Certain institutions considered too big to fail must be broken up, including Goldman Sachs and Citigroup. But many other, less visible, firms deserve to be dismantled as well. Moreover, Congress should resurrect the Glass-Steagall banking legislation that it repealed a decade ago but also go further, updating it to reflect the far greater challenges posed not only by banks but by the shadow banking system.
These reforms are sensible, but even the most carefully conceived regulations can go awry. Financial firms habitually engage in arbitrage, moving their operations from a well-regulated domain to one outside government purview. The fragmented, decentralised state of regulation in the United States has exacerbated this problem. So has the fact that the profession of financial regulator has, until very recently, been considered a dead-end, poorly-paid job.
Most of these problems can be addressed. Regulations can be carefully crafted with an eye toward the future, closing loopholes before they open. That means resisting the understandable impulse to apply regulations only to a select class of firms â?? the too-big-too-fail institutions, for example â?? and instead imposing them across the board, in order to prevent financial intermediation from moving to smaller, less-regulated firms.
Likewise, regulation can and should be consolidated in the hands of fewer, more powerful regulators. And most important of all, regulators can be compensated in a manner befitting the key role they play in safeguarding our financial security.
Central banks arguably have the most power â?? and the most responsibility â?? to protect the financial system. In recent years, they have performed poorly. They have failed to enforce their own regulation, and worse, they have done nothing to prevent speculative manias from spinning out of control.
If anything, they have fed those bubbles, and then, as if to compensate, have done everything in their power to save the victims of the inevitable crash. Thatâ??s inexcusable. In the future, central banks must proactively use monetary policy and credit policy to rein in and tame speculative bubbles.
Central banks alone canâ??t handle the challenges facing the global economy. Large and destabilising global current account imbalances threaten long-term economic stability, as does the risk of a rapidly depreciating dollar; addressing both problems requires a new commitment to international economic governance. The International Monetary Fund (IMF) must be strengthened and given the power to supply the makings of a new international reserve currency.
And how the IMF governs itself must be seriously reformed. For too long, a handful of smaller, ageing economies have dominated IMF governance. Emerging economies must be given their rightful place at the table, a move reinforced by the rising power and influence of the G20 group.
All of these reforms will help reduce the incidence of crises, but they will not drive them to extinction. As the economist Hyman Minsky once observed: â??There is no possibility that we can ever set this right once and for all; instability, put to test by one set of reforms, will, after time, emerge in a new guise.â? Crises cannot be abolished; like hurricanes, they can only be managed and mitigated.
Paradoxically, this unsettling truth should give us hope. In the depths of the Great Depression, politicians and policy-makers embraced reforms of the financial system that laid the foundation for nearly 80 years of stability and security. It inevitably unravelled, but 80 years is a long time â?? a lifetime.
As we contemplate the future of finance from the mire of our own recent Great Recession, we could do well to try to emulate that achievement. Nothing lasts forever, and crises will always return. But they need not loom so large; they need not overshadow our economic existence.
If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry. But if we fail to prepare for the inevitable hurricanes â?? if we delude ourselves, thinking that our antiquated defences will never be breached again â?? we face the prospect of many future floods.
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Comments: 14
There have been tens of thousands of pages of dense, abstruse financial regulations to date. Piling more on will not fix the problems inherent in a monetary system that is flawed in its very conception. The nature of a fiat,debt-based money managed by a fractional-reserve banking cartel is inherently fraudulent. Fiduciary media created out of nothing but promissory notes is not real money! Real money is commodity money, gold or silver preferably, and loans have to be made only from prior savings of such money, not ex nihilo according to the whims of bankers legally empowered to turn us into indentured servants to a privileged financial class. The interest rates on such loans have to be hammered out in a true free market in capital, something we have not had since 1913 with the passage of the Federal Reserve (a prime example of a regulation gone astray). A group of so-called monetary experts sitting around a table in the Den of Charlatans hardly possesses the know-how to set interest rates on monopoly money, let alone the medium of exchange necessary in our diverse economy!
it's all nice. but, there are an awful lot of musts. if things were better should they go on as roubini proposes, why aren't they already like that? stuff like derivatives operations simply cannot be mended. will they be prohibited? what about the incentives of all financial sector employees and stockholders, and also regulators? can the be aligned with long term social benefits? i sincerely doubt it. and that's the heart of the matter. j
Rating agencies should not be listed companies either. As seen elsewhere this now leads to the quick buck mentality with all the cutting of corners that go into squeezing that little extra "shareholder value" out of the operation.
talking about the Corporation called the United Kingdom, right? Learn how to remove yourself from the liabilities of the Corporate debt of the United Kingdom Government Corporation by studying: 'Winston Shrout.' Free video's on youtube.
Securitization is ILLEGAL, period! They are acting like the crime is legal, it just needs some oversight. You could say the same thing for a cop telling the robber: "You need to carefully pick the lock...so as not to damage it." They think they know so much and they do not......securitization is illegal....it violates usury legislation, anti trust and bankruptcy laws, and is a tax evasion instrument.
"Or to use a sausage-making metaphor: if you put rat meat and trichinosis-laced pig parts into your sausage, then combine it with lots of other kinds of sausage (each filled with equally nasty stuff), you havenâ??t solved the problem; you still have some pretty sickening sausage." 000000000000000000000000 So, the Banker in colonoosion with the tinker the tailor and the candlestick maker ,will carry on recycling their FOUR trippleAAA perfumed skins until it brings out the wurst in them lol we've had the stoneage the bronze age and ironage now we have the saaausage and car go cult scrappage scheme all thanks to the thinking of the entitlement!
Regulation Definition - rule designed to control the conduct of those to whom it applies. Regulations are official rules, and have to be followed. Simple solution change the regulations so that the suckers (families) dont't get burnt to the crisp.
I love it. These lovers of financial market freedom just don't get it. Any attempt to restrict them is branded as socialist. Excuse me, but that is sooo last century. Welcome to the new millenium! You and your ilk have - through your twisted greed - destroyed the financial market economy as it was. Truly you are the dog that ate its own tail. And yet you want to carry on eating! You still don't get it, you just want to be allowed to carry on regardless! On the other hand, that's handy in a way, because even though the system of unrestricted greed has brought the financial system to its knees, there are still some out there who think it can be reformed, who still don't understand that the economic and social structures under which the world has been run really are finished. The game is over, guys! Like cockroaches that have been hit, with one leg hanging off, you still manage to run. Thankfully, it's not long now before you will all be lying on your backs. The world will be a better place.
John Lafer on May 04, 2010 at 07:16 PM John gets it - Roubini doesn't Roubini caricatures the financial markets as a "gangrenous mess. " His critique should start with the socialist policies followed by successive US governments. Roubini, try Freddie Mac and Fannie Mae for starters. Who dreamed up these monsters of wealth destruction? The financial markets? Roubini is on fire duty for scum bag socialist politicians. Roubini is advocating new regulations that have nothing to do with improving the efficiency of the financial markets and everything to do with protecting socialist / progressive politicians from the financial markets. Classic progressivism from Roubini.
We have the biggest, most regulating governments ever, and yet they couldn't prevent the financial crisis. Yet, Rubini says the solution is more government, more regulation. That's pure insanity. What we need is more consequences and fewer bailouts with other people's money. That's the missing "regulation."
Nouriel Roubini and Nassim Nicholas Taleb ( my Hero) should be in charge of the Treasury department and Fed together and let them make changes to the financial systems. the rest are goldman sachs employees
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