cityaznguy saidI thought the source of the financial crisis is the Federal Reserve, we have specifically Greenspan and Bernanke to thank for that.
Oh, greed too, absolutely. There are toxic assets everywhere! What's even more concerning is that the government (not just the USA) keeps absorbing these toxic assets by pumping money into the fragile economic system in an attempt to solve the liquidity problem. I have a bad feeling that Greece is going to default and that will drag down Ireland, Portugal, Spain, and Italy. If Spain, the 10th largest economic entity, goes down the entire EU gets dragged down. I'm scared of the domino effect will be similar to when Bear Stern went down, who knew that there were so many hidden problems in the financial system? I blame it on the overpackaging of the financial derivatives. They shouldn't exist in the first place.
I don't think the problem is with the financial derivatives and I'd be concerned about who the arbiters of "overpackaging" are. Instead I think if there are interventions, it should be ones made to encourage further disclosure/transparency and let buyers themselves decide if the assets are worth buying.
Derivatives have their place - it's effectively an insurance product but also one that allows institutions to both take on and unload risk. It was pointed out by Greenspan after the telecom crash that before derivatives, the failure of the funded telecoms would have also resulted in a financial crisis. Instead, in that case, derivatives helped move risk and losses off the balance sheets of banks onto those of insurers, hedgefunds while ensuring liquidity. What made this market crisis different was that no one was sure what to believe and therefore buyers effectively froze the market unwilling to buy at any price because of they had no idea what the specific underlying assets were. In many cases, even the sellers had no idea - given the complexity and lack of transparency of the instruments.
I agree with your view on confidence
. Ultimately the market always boils down to the confidence of investors. It's the same thing with currency. It only costs like 20 cents to create a $100 federal reserve note, but what people believe in is the purchasing power of what that piece of paper represents.
I guess disclosure/transparency of the derivatives would help the confidence of investors. But what I don't understand are these:
1. Regardless of being transparent or not, won't these create more leveraging in the market? And when the money supply dwindles and deleveraging starts then it creates the liquidity problem? But I guess it's true for all financial investments if you don't play with your own money 100%.
2. Increasing transparency of these derivatives would perhaps decrease the the attractiveness of them, especially if the underlying assets are toxic ones. Then it will not draw longterm buyers, because who wants to hold potentially toxic assets for the long run. People would want to hit it hard and short and leave.
I'd like to hear your thoughts on that