Sytems failure

What's all this talk about a "failed business model"? Wall Street's securitization business model worked perfectly: For a substantial fee, redistribute risk to willing investors. As data on the risk improves, tranche it even more finely and redistribute it again. The most sophisticated investors take the greatest risk and reap the greatest rewards. Worked fine. What failed Wall Street and the commercial banks was their credit- and market risk management systems. What failed the public was the impossibly archaic regulatory environment. Risk correlation was incorrectly assessed and insufficiently tracked. In order to facilitate underwriting mandates and instill investor confidence, underwriters and mortgage originators kept risk that should have been priced appropriately and placed with investors. The proper pricing of risk was second fiddle to underwriting fees and league table standings. Risk controls were routinely over-ridden by business managers in the interest of short-term gains. Institutional greed was not the problem; rather, the institutionalization of poorly structured compensation packages to business units provided incentive to mislead risk managers as to the true nature of the risks being underwritten. Every day, the mismatch between controllers scrambling to keep up with ever more complex transaction structures became more imbalanced in favor of the business units. This situation is mirrored in the inability of regulators - SEC, FSA, et al - to fully comprehend the severity of potential losses on financial institutions' balance sheets. FAS and IAS guidelines were and are incoherent on the issues, leaving crucial reporting items open to interpretation by accountants (who, like the rating agencies, are paid by the financial institutions!). The sudden realization that risk was not being correctly represented in public filings and reports will be reprised when the credit derivatives market starts to wobble. Right now, the Fed and ECB are trying their level best to stop this from happening, but the credit derivatives market is a $70+ trillion behemoth with immense potential for damage. And the beautiful thing is that no-one knows where the risks are highest, as exposure under credit derivatives is poorly reflected on balance-sheets as a result of pitiful and vague accounting rules. The fun has only just begun.