There is not a magic set of policies that will prevent financial bubbles and thier aftermath. Systemic risk is here to stay regardless of our collective actions and/or policies.
While is is a favorite pastime of economists and CNBC talking heads, assigning blame for this last financial bubble is a bit of a red herring. Why? Because history is replete with bubbles, panics and crashes; all of which, by the way, managed to take place without the benefit of CDS contracts. Please read Kindleberger’s "Manias, Panics, and Crashes" for many well documented examples.
Yes, CDS contracts played a role in this last blowup. Clearly, they slipped through the regulatory cracks and became vehicles for outrageous leverage and money creation. They do not, however, explain how the savings rate in the country fell below 1%. They do not explain how non-professionals poured into the real estate market to 'flip' houses and condos. They didn’t push the NASDAQ to 5000.
This brings us to the money creation at the Federal Reserve. Yes, it would appear, after the fact, a prolonged policy of low interest rates earlier this decade contributed to these problems. But, without the benefit of hindsight, at the time, there were serious concerns about deflation. If your next thought is to get rid of the Fed, then tell me how that will prevent another bubble. Again please read Kindleberger for a list of bubbles without the benefit of a federal reserve.
Fantasizing about a world without financial bubbles, is like saying if we had right policies, we could stop war or famine. It's an unrealistic goal and is most often used to generate political leverage. Or, in the case of the media, an endless story to sell diapers, cars and retail brokerage services.
The lack of statutory guidelines for such events is what bothers me. The Hobson’s choice of whether or not to bail out theses behemoths on an ad hoc basis yields some terrible results. You end up helping the organizations that did the most damage (AIG, anyone of a number of overleveraged banks..etc.)
A realistic approach would be to accept the inevitability of these integral parts of the human condition. We should, as a society, save money for such eventualities and provide support for individual citizens during time of stress; not companies. A national insurance fund that kicks in during an economic crisis might work.
Pretty crazy idea, right? Saving money for a rainy day…..