More fundamentally, and looking beyond the immediate crisis, it is clear that the international community needs to work to close the many loopholes in the global regulatory architecture that allowed financial institutions to minimize capital even as they concentrated risk.
Look, if even the MD of the IMF gets this wrong then we\’re all doomed. Financial institutions did not concentrate risk. They dispersed it! That\’s what the damn problem is, the risk is all over the place and we don\’t in fact know exactly where.
When a German bank falls over because of problems in the mortgage markets in Florida and California, that\’s really not a concentration of risk, is it?
It’s less that we don’t know where the risk is. It’s that we don’t know what it is.
No, we do know exactly what it is – it’s the shortfall between the outstanding balance of US residential and commercial mortgages and the medium-term value of the property they’re secured upon (plus a bit for other housing bubble countries, but given the relative size of the markets the non-US stuff is just noise).
The former we know exactly; the latter we can make some reasonable guesses – what we don’t know is which banks are holding the loans that aren’t going to pay back and which are holding the loans that are.
Only to a degree. The point’s about the risk being in the banking system. It was claimed that all the financial innovation and repackaging of debts meant that risks had been dispersed from the banking system to a whole host of other investors.
This has happened to an extent – AIG – but not in the sense that the banks are all in deep trouble and being bailed out.
There was a good Economist article 5 years ago
http://www.economist.com/finance/displaystory.cfm?story_id=E1_TJRJQPD
Yes, the risks were dispersed. I think the IMF guy’s statement would be better as
“allowed financial institutions to minimize capital even as they massively increased risk”.
The reality of dispersing risk lead to the delusion that the system could support a lot more of it.
John B hits the spot.
My worst case calculations for losses suffered by UK banks on home loans is about £40 billion, and that’s assuming around 1 million repossessions and a 42% fall in prices from peak. That’s only about 3% of total UK household borrowing, and nothing that can’t be fixed by converting 25% of long term bank debts into equity.
Ed is correct in his correction.