FixedIncomeRisk Forum

FYI, re: Basel II

http://pages.stern.nyu.edu/~pwachtel/basel.pdf

Though an old article from 2004, it now seems so prescient! The cap requirements in Basel 2 could hardly keep up with all the problems with structured credit in the past year.

Sometimes, simplicity is good.

The complex innovations in structured credit allowed the monitoring function of banks to be thrown out of the window, as banks got busy packaging loans to simply give them away to all these suckers in the hedge fund industry.

In general, we need banks to keep the risky long-term loans that they make on their OWN books. We can't force them to do this is a free market, but given the implicit FDIC guarantee etc., the govt. does have a stake in controlling the bad behavior of banks. Otherwise, too much perverse incentives get in the way in structuring these fancy credit products to make a buck at someone else's expense. At some point we will need a Basel III may be to deal with all the chaos unfolding right now.

Your comments are really interesting.

I think it is interesting that the perspective here is keeping riskly loans on bank balance sheets when in Japan in the 90s it seemed to me that we wanted their banks to get rid of their bad loans.

You probably know way more than me on this but I would like to hear more when you can.

I agree the Govt., actually probably the Fed but perhaps the Treasury's Comptroller of the Currency dept., needs to have some oversight wr banks ability to add risk to the system. In the purest of free market system there is no barrier to agents (in this case banks) from pursuing their own interest (higher earnings) in a way that is counterproductive to the system as a whole. I'm not suggesting price controls, just things like capital controls or other measures to prevent excess risk.

It seems to me that contagious nature of financial risk deserves greater scrutiny in modern financial markets.