Regular readers know there has been one change. The prescriptive financial regulatory industry has grown by leaps and bounds. Look at all the detailed regulations that are being churned out under Dodd-Frank. By doing so, they have protected opacity across large areas of the financial system.
"I was on holiday in the runup to the collapse of Lehman Brothers, when the crisis exploded. I remember opening up the paper every day and going: 'Oh my god.' It was terrifying, absolutely terrifying. We came so close to a global meltdown. ....
Now here we are four years later, and the most incredible thing has happened – we've learned nothing from the whole thing. Everybody pretends it's all OK. ...
"If you had told people at the height of the crisis that four years later we'd have had no fundamental changes, nobody would have believed you. Such was the panic and fear. But there we are. We went from 'We nearly died from this' to 'We survived this'.It is a real testament to the power of the prescriptive financial regulatory industry that they were able to block the return of transparency to all the opaque corners of the financial system. Instead, we have a bunch of one-off regulations that attempt to achieve what transparency would do.
For example, we have issuers retaining an interest in structured finance securities. The reasoning being that this will give the issuers an incentive to underwrite less toxic junk.
If there were true transparency into the underlying collateral, investors would not care whether the issuers retained an interest or not. With true transparency that includes observable event based reporting, investors could assess the risk of the underlying collateral and know what they own.
If a deal includes high risk assets, the investor would demand a return that compensated them for the risk of the assets.
"Have you read Gillian Tett's Fool's Gold about the crisis? It was exactly like that. You had bankers who did not understand their own complex financial products but thought that they did, and then raters who took their word for it. And nothing has fundamentally changed.
"As most people understand by now, lots of sub-prime mortgages were bundled by banks into financial products and sold on to investors. These believed they bought a very safe thing because the products had been rated triple A, which meant that there was only a 1% or so chance of a default.
"When the crisis hit, it hit hard, reality kicked in and the rating agencies suddenly downgraded triple A products to junk status in a matter of days. I won't call it fraud; I will call it a 'desperate revision of history'.In the absence of transparency into the underlying collateral, investors turned to the rating agencies who failed to inform the investors that they had no better access to information on the underlying collateral than did the investors.
This was not clarified until the fall of 2007.
"Overall, it was more incompetence than outright fraud. .... As far as the rating agencies were concerned, it was incompetence brought on by short-termist, bottom-line thinking by senior management who just wanted to make money. That meant rating as much as possible, as often as possible....
"When asked about the crisis, rating agencies use the defence that the bankers who designed those complex financial products did not understand them themselves. So how can rating agencies be blamed for not understanding them either**?
"But you shouldn't just rely on the information given to you by the people whose product or company you are rating....
"With every new financial product, raters should be asking: have the products been tested properly? Are they modelled for all possible conditions, so boom as well as bust times? Do we even know what it does in every phase of the economic cycle? Do we know how the product is likely to evolve over time, how will it behave when it develops into a bubble?Investors should be asking the same questions. In addition, investors should not invest unless they are sure that there is transparency so that they have access to all the useful, relevant information in an appropriate, timely manner so they can make a fully informed investment decision.