Financial Meltdown

In the comments section on today's "The Economist" article on the financial meltdown, a plucky commentator informs "The Economist" that their next headline should be "We told you so." Unfortunately, in a rare occurrence, they didn't "tell anyone so", but rather, they have repeatedly lauded the creation of the derivative markets that are responsible for this mess. The Economist's logic has been that these markets spread the risk to those most willing to bear it.

That, in principle, was true. Unfortunately however, the investors who ended up holding these risks, had no idea of the risk involved. They took names like AIG and Morgan Stanley to be safe bets... "risk" was getting crazy in some developing market in Indonesia. So although the risk from CDOs was spread, the nature of risk was not understood by those who held it. Thus, the justification of spreading risk to those who have appetite for it simply falls flat.

Capitalism is NOT to blame. "Greed" may be to blame, but only in so far as "greed" can be understood as deception or doggy tactics in seeking fortune, seeking fortune in and of itself is not responsible. The deception, and responsibility for this mess, lie with the unscrupulous mortgage brokers (who invented income so clients could buy bigger homes that they couldn't afford), investment banks who commoditized this debt and sold it on without checking if the asset it was based on (the McMansion) was really worth what the loan said, and the "financial services representative" who understated the risk in selling these packages to consumers. The consumer, as well, is not blameless... because ultimately parting a fool and his money is not hard and the consumer had a responsibility of due diligence to see if the I-banker was selling snake oil or something real.

Credit derivatives are largely done, as is I-Banking as a stand alone model. You can't just keep creating assets that don't have any value other than spreading risk - they have to ultimately be tied to something real - otherwise you are just pulling rabbits out of the hat...