The first is the unquestioning belief – naturally inherent in legislators – that more oversight is better. The bill is littered with new authorities, agencies and councils. But the truth is that the global financial system was already scrutinised by hundreds of governments, regulators and central banks, not to mention private rating agencies, consultancies and analysts. None of them spotted trouble last time – neither will this new lot next time.

Punishing the innocent is the bill’s second flaw. It is a real mystery why proprietary trading, private equity and hedge funds emerged as baddies. They had absolutely nothing to do with the financial crisis, and indeed performed pretty well over the period. Nor did mortgage-related structured derivatives blow up because they were traded “off exchange”. They exploded because house prices dropped.

The final flaw is that the real problems have not been addressed. In order of importance: banks remain woefully undercapitalised; no one really believes the biggest lenders will be allowed to fail; there are inherent distortions in the system such as government-insured deposit-capital; Wall Street and Washington remain bedfellows. This legislation guarantees plenty of paperwork and desk shuffling, but the next crisis is already germinating undetected somewhere.

...
And then, 2009 brought one of the fastest rallies in history.

News from the “real world” cannot possibly explain this. Why were markets so much more prone to bubbles? It is fashionable to blame greed. But this makes little sense; it implies that, worldwide, people have suddenly become greedier than they used to be. Greed, surely, is a constant of human nature. Rather, it is more accurate to say that in the past half century, fear has been stripped from investors’ decisions. With greed no longer moderated by fear, investors are left overconfident.
...
How did this happen? I suggest it is down to what might be called the fearful rise of markets. Over the decades, the institutionalisation of investment and the spread of markets to cover more of the global economy have inflated and synchronised bubbles. This rise of markets has brought several trends in its wake, all of which seemed to have contributed to the eventual disaster of 2008.

Other people’s money. In the 1950s, investment was a game for amateurs, with less than 10 per cent of the stocks on the New York Stock Exchange held by institutions; now institutions drive each day’s trading. In the past, lending was for professionals, with banks controlling virtually all decisions. Now that role has been taken by the capital markets, which businesses can tap for funding. As economists put it, in both investing and lending, the “principals” have been split from the “agents”. When people make decisions about someone else’s money, they lose their fear and tend to take riskier decisions than they would with their own money.

Herding. The pressures on investors from the investment industry, and from their own clients, are new to this generation, and they magnify the human propensity to crowd together in herds. Professional investors have strong incentives to crowd into investments that others have already made. When the weight of institutions’ money goes to the same place at the same time, bubbles inflate.

Safety in numbers. Not long ago, market indices were compiled weekly by teams of actuaries using slide rules. Stocks, without guaranteed dividends, were regarded as riskier than bonds. Now computerised mathematical models measure risk with precision, and show how to trade it for return. When academics produced these theories, they were nuanced with many caveats. Their psychological impact on investors was cruder. They created the impression that markets could be controlled, and that led to overconfidence. They also promoted the idea that there was safety in diversification – investing in different assets. Diversification per se is almost impossible to argue against, but this notion ended up encouraging risk-taking and led investors into markets they did not understand. This in turn tightened the links between markets.

Moral hazard. As memories of the bank failures of the 1930s grew fainter, governments eventually dismantled the limits imposed on banks in that era. Banks grew much bigger. Government bank rescues made money cheaper while fostering the impression among bankers that there would always be a rescue if they got into trouble. That created moral hazard – the belief that there would be no penalty for taking undue risks. Similarly, big bonuses for short-term performance, with no penalty for longer-term losses, encouraged hedge fund managers and investment bankers to take big short-term risks and further boosted overconfidence.

The rise of markets and the fall of banks. Financial breakthroughs turned assets that were once available only to specialists into tradeable assets that investors anywhere in the world could buy or sell – at a second’s notice. Emerging market stocks, currencies, credit, and commodities once operated in their separate walled gardens and followed their own rules. Now they are all interchangeable financial assets, and when their markets expanded with the influx of money, many risky assets shot upward simultaneously, forming synchronised bubbles. Meanwhile, banks saw their roles usurped by markets. Rather than disappear, they sought new things to do – and were increasingly lured into speculative excesses.
...
There is one big problem when it comes to fixing these underlying factors – most of them are good ideas. Most of us need a professional institution to run our money for us; money market funds, or securitised mortgages, are popular because they help people raise money swiftly and cheaply. Further, the propensity to inflate bubbles is in the very fabric of world markets, so any reforms need to be systemic. While the absurdly complicated instruments that created the subprime bubble, such as the synthetic collateralised debt obligations that landed Goldman Sachs into trouble with the Securities and Exchange Commission, should go, the roots of the problem lie far deeper. Finding fixes will involve hard choices.

Making this harder still, any solution must be filtered through human nature. Our tendency to suffer swings of emotion, to move in herds and to expect others to rescue us from the consequences of our actions, are never going to go away. So while I felt quite good about the diagnosis of the problem, I should be much more humble when proposing a solution. But in outline, I do have some ideas how markets can be made more fearful, and maybe more efficient.

Moral hazard. Previous financial crises reined in moral hazard by inflicting grievous losses on key investors. The latest crisis was different – it showed that the US, the UK and other governments would spend trillions of dollars to sustain the biggest financial groups. Now, the belief that risk takers will be rescued is stronger than ever. So air must be taken out of markets that are currently betting that the government dare not let them fail. It is still too soon to do that. But at some point, either by raising interest rates or by allowing a big bank to go down, government must make clear it will not be there to bail out the reckless.

A safe place to start would be the megabanks like Bank of America, which are even bigger as a result of shotgun mergers which were arranged during the crisis. They cannot be allowed to fail; instead, they must be regulated so tightly that they simply are not allowed to gamble, or they must be made smaller. Governments could raise reserve requirements, which in practice would force banks to sell off assets; this need not involve imposing a break-up.

The decline of banks and the rise of markets. The rise of money markets created a new class of bank-like institutions that do not need to buy insurance to protect depositors. This shadow banking system, including money market funds (mutual funds that invest in the money markets), must now be regulated as if they were banks. Reforms to solidify the so-called repo market (in which banks borrow from each other over very short periods, putting up bonds as collateral) are vital. When this market seized up, banks were unable to get short-term funding.

Regulators also need to overhaul the rules that inadvertently spurred banks to pile into mortgage-backed securities and outsource to rating agencies their central function as lenders – figuring out who can pay back a loan and who cannot.

Like unemployed teenage boys, these banks have shown a terrible knack for getting into trouble when left to their own devices. Once money markets are subject to the same regulation as banks, their advantages may evaporate, enabling banks to regain their old businesses of lending. If not, the economy can possibly do without banks in their traditional form. Hedge funds drove many trends to destruction by 2007, but the much-feared disorderly collapse of a big hedge fund did not occur. Instead, it was the inherent instability of banks that brought the roof down. And so for banks, the status quo is not an option.

Other people’s money. Banking system reforms must also address the conflicts between principals and agents that arise whenever those who take on a risk are able to sell that risk to other parties. In securitisation, where some principal-agent split is inevitable, loan originators must be required to hold a significant proportion of their loan portfolio – in other words to “eat their own cooking”. Investment banks that are now public might return to the partnership model. Then the money on the line would be that of the partners themselves, not shareholders. Again, this might not require government intervention. Existing investment banks could go private. Or hedge funds, which increasingly already carry out investment banking functions, could evolve further.
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And after three hectic years attempting each day on video to explain markets that had fundamentally deviated from common sense, it is a trade-off I too would make.

John Authers became head of the FT’s Lex column in April. This is an edited extract from his book ‘The Fearful Rise of Markets’

A credit-default swap is not a free-market financial instrument.

Why? Because there is only one reason why a party holds a CDS. They have government permission to overvalue these securities on their balance sheets. CDS are an artifact of incorrect government-mandated accounting (specifically, via the NRSROs).

What is the market value of a CDS? There are two answers, A and B, the wrong answer and the right answer. The wrong answer is: the market value of a CDS is the chance that the credit default will happen, multiplied by the face value of the CDS. X times Y.

The right answer is: the market value of a CDS is the chance that the credit default will happen, multiplied by the chance that the CDS issuer will not default, multiplied by the face value of the CDS. X times Q times Y. So, if you buy a CDS on an IBM bond from AIG, its market value is the face value, times the probability that IBM will go bust, times the probability that, if IBM goes bust, AIG will not go bust.

Now, the people who invented these things are not actually stupid. They didn't forget about Q. What they said was: Q is the probability that AIG will go bust. They then said: AIG has an AAA credit rating, which means it will never go bust, with 99.999% probability or whatever. Setting Q to basically equal 1, they then arrived at the desired calculation of value, ie, X times Y.

But this is just bad probability, which makes it bad accounting. The probability that AIG will go bust if IBM goes bust is a conditional probability. X and Q are not independent variables. For one, AIG, having written a lot of these IBM CDS, will lose a lot of money if IBM goes bust. And any event that affects IBM may affect other companies on which AIG has also written swaps.

The CDS buyers also required (or should have required) AIG to collateralize these positions. But collateral, too, is not a magic amulet against counterparty risk. If you've insured $3 billion worth of diamonds, and you only have $100 million to cover them, when the probability that the diamonds are stolen flips from very low to certain, someone will get burned. It's just math. Until capital equals exposure, someone has to end up holding the bag.

Collateralizing an undercapitalized insurance market does not protect the market from insolvency. It just means the market melts down in a flash, as all positions are liquidated - the price of CDS will rise faster than the sellers can buy back their CDS. Someone won't be able to; and whoever holds his CDS will experience the ugly stick of Q. If collateral is centralized through a clearinghouse, that clearinghouse must be able to cover all the diamonds it insures, or the clearinghouse has significant default risk.

As we saw in the case of AIG, of course, the problem was solved. Who wound up holding the bag? You, of course, dear taxpayer. And this is why I say that CDS are not a free-market instrument. The Q is all on you.

The basic problem with CDS as a free-market instrument is that, while there is quite a bit of demand for the product of exposure X * Y, there is little or no demand for X * Q * Y. For instance, if you buy an IBM bond and an AIG CDS against it, you have replaced your exposure to an IBM default with exposure to an AIG default.

In reality, no party (except USG) is really so much more financially secure than IBM, that it's worth writing insurance on IBM. The financial product that the market demands is not CDS, but CDS without counterparty risk. This is a useful product indeed, but not a free-market product. No free market can produce any such thing - it takes a fiat-currency issuer. To guarantee IBM's loans risk-free, you would need to cover every dollar of IBM loan with an insurance dollar, which would be ridiculous, unprofitable, stupid, and completely defeat the purpose.

Thus, people buy CDS because (and only because) incorrect accounting principles allow them to incorrectly disregard Q, the probability of the CDS issuer defaulting, thus assigning these securities excessive value on their balance sheets. When they become insolvent as a result of this miscalculation, USG's infinitely-flexible rubber-dollar absorbs the slack, and the Fed becomes the new team sponsor of Manchester United.

Je vois aucun sous entendu, leur phrase est explicite et parfaitement intelligible : c'est pas le trading "off exchange" qui les a fait s'effondrer.

Ensuite, considérer que ces acteurs sont indépendants de la titrisation alors que ces produits financiers leur étaient aussi un peu destinés et qu'ils se sont diffusés aussi à travers eux...Hum hum.

Pas de prise en compte du risque de liquidité.
Une plate-forme d'échange accompagnée d'une autorité de régulation spécifique aurait pu prendre en compte ce type de risque et éventuellement le prévenir ou prévoir des mécanismes adéquats.

Le saviez vous ....

Les recettes fiscales de l'etat en 2001 etait 245 milliards (Sources: Assemblée nationnale, loi de finances 2001)

Dès 2003, c'est a dire un an après à l'arrivé de la droite aux pouvoirs, les recettes baissent à 241 millards (Sénat, loi de finances 2003)

- De 2003 à 2009 les recettes de l'etats n'ont fait que baisser plus de 10 milliards (source insee) 231 milliards alors que la dette dans la même période est  passée (en gros) de 850 milliards a 1500 milliards pratiquement doublée.

On doit ajouter que le PIB pour la période (2001/2009) est passé de 1475 milliards à 1607 milliards  soit près de 9% d'augmentation. Ce gouvernement n'a même pas cherché a coller au PIB pour ses recettes, n'ayant qu'un but et une idéologie, faire plaisir aux plus riches, au patronat et avoir le moins d'impôts possible.  
La réalité venant de lui exploser en pleine tronche il essai de colmater les brèches béantes du paquebot France entrain de sombrer...

Et toujours la même rengaine.. pas d'augmentations d'impôts pour les nanties !!!

Hors, on voit quoi pour le budget 2010 ? (insee) une augmentions des recettes de fiscales de 15%  tout en continuant de baisser les impôts sur les sociétés de 40% . Et il les prend ou ces 15 % (36 milliards) ? Ben sur les taxes et autre impôts direct  +104%

Punishing the innocent is the bill’s second flaw. It is a real mystery why proprietary trading, private equity and hedge funds emerged as baddies. They had absolutely nothing to do with the financial crisis, and indeed performed pretty well over the period. Nor did mortgage-related structured derivatives blow up because they were traded “off exchange”. They exploded because house prices dropped.

Il prétend que si elles posent problème, c'est uniquement parce que le marché immobilier s'est effondré.

Il prétend que si elles posent problème, c'est uniquement parce que le marché immobilier s'est effondré.
Non : il n'explique pas en quoi elles posent problème, il explique pourquoi leur valeurs se sont cassées la gueule. Et effectivement, la chute de ces titres tien à la chute des collatéraux (c'est à dire, je te le donne en mille : la valeur des maisons). Si les collatéraux ne baisse pas, les titres non plus.