When I write, I don’t always know what will be popular, and what won’t. Personally, I thought my article Rethinking Insurable Interest was the more innovative of my two articles yesterday, but Blame Game made the splash. Well, perhaps no surprise, the crisis has the attention of all of us. I just have broader interests; I want to write about a wide number of things.
My readers took me up on my request, and gave me more targets to blame. Let me expand on them:
21) The Rating Agencies — that was a popular choice. Yes, the rating agencies messed up. They always do. Their job is an impossible one. Should they be proactive or reactive? Should they rate over the cycle, or be instantaneous? Should they care about systemic risk issues?
Where they did err? They competed for business, leading underwriting standards lower in structured finance. They overrated the financial guarantors, who were their major clients. Away from that, they made mistakes, but every firm offering opinions makes mistakes. I make mistakes regularly here.
22) Matt give me another party to blame, and I will let him speak for himself: I have one more to add - the Office of the Comptroller of the Currency. Not only did they fail to regulate the national banks, they also stone-walled State and local governments from bringing suit (claiming jurisdiction, but never following up on claims).
Add to that the divided regulatory structures that encouraged regulatory arbitrage. That encouraged diminished underwriting standards.
23) Investment banks. They asked the SEC to waive their leverage limts, and now none of the big guys are left as standalone publicly traded institutions. They made a lot for a while, and then lost more.
24) Then there were the carry traders who have now gotten carried out on their shields. There were too many players trying to clip uncertain interest spreads, from hedge funds to Japanese housewives…
25) House flippers — whenever investors get to be more than 10% of a real estate market, beware. Sad, but I heard an ad on the radio for buying residential real estate in order to rent it out. It is not time for that yet.
26) The quants — they enabled models that gave a false sense of security. They did not take into account decreased lending standards, and assumed that housing prices would continue to go up, albeit slowly.
They also assumed that various classes of risky business would be less correlated, but when hedge funds and fund-of-funds take many risks, returns become correlated because of investoors entering and exiting sectors.
27) The tax havens and hedge funds. Hedge funds are weak holding structures for assets. In a crisis they can be sellers, because they want to lower leverage.
28) Mainstream financial media — CNBC, etc. They were relentless cheerleaders for the bull markets in stock and housing. This isn’t a compliment, but financial radio makes CNBC sound cautious. FInancial radio seems to be a home for hucksters.
And, that’s all for now. If you have more parties to blame, feel free to respond. One final note on my point 16, diversification, from the prior post: Many quants did us wrong by focusing on correlations stemming from only boom periods. There are many problems with correlation statistics in finance, but the big problem is that correlations are not stable even during boom times, much less between booms and busts. In a bust, all risky assets become highly correlated with each other, invalidating ideas of risk control through diversification.
My view of diversification is holding safe assets and risky assets. High quality short-term debt does wonders to reduce the volatility of results. Other hedges are less certain. Nothing beats cash, even when money market funds are open to question.