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Systemic Failure

Posted in Finance by Pankaj Gudimella on March 14, 2009

Barry Ritholtz on factors which led to systemic failure

The perfect-storm metaphor is imperfect; rather, what led to the current situation were numerous legislative, ideological, and business decisions that worked together to create a systemic failure. Consider each of the following:

* The Commodities Futures Modernization Act (2000) allowed unregulated derivatives to run wild.
* The repeal of Glass-Steagall (1999) allowed depository banks to become far more intertwined with Wall Street.
* From 2001-03, Fed Chair Alan Greenspan took rates down to unprecedented levels, causing 1) a mad scramble for yield and 2) an enormous housing boom.
* In 2004 the SEC allowed the five big investment banks to leverage up from 12-to-1 to 35-to-1 or more.

Reverse each of the above and the total systemic damage is far, far less. There were several other factors—the changing business model of the ratings agencies from customer-financed research to a form of payola and the misaligned compensation system on Wall Street that pays people for short-term gains despite ongoing long-term risks. There’s a lot more, but I cannot forget the misguided deification of markets—a false belief system that led to a radical deregulatory philosophy that ignored the abdication of lending standards (“Innovative,” said Greenspan) among the subprime lenders.

Source:Slate

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