1. Whiteknight said...

This is unfortunately an attempt to support a faulty system.

It is probable that the credit system is entirely wrong in any case.
It is highly likely that many of the mathematical models used to compute market "realities" are also wrong in times of stress
It is likely that banking in terms of lending should drop 3rd order derivatives and go back to the 3-6-3 rule. (Borrow at 3%, Lend at 6%, Be on the Golf Course by 3 O'clock).

Actually this is not really a serious suggestion, but there are a couple of things that certainly should be put in place.

Regulation should instead recognize that in the modern financial world everything breaks down into a cash flow (or set of cash flows) and the probability that the cash flow will occur. Hence instruments that are regulated carefully can be created synthetically by other means (unregulated) and also new and 'stranger' behaving cash flows can be created.

In turn, you can then insist on rules of how a position on the market is financed. These would need to be conservative since we have demonstrated that contagion effects and variable correlation under stress cause havoc when you are running at full steam with no remaining capacity.

At the moment we are more likely to have a derivatives based witch hunt, which will be a shame.

Over the last two days, the solution from the Central Banks to years of lax lending and credit terms has been to offer unlimited short term loans to banks with no terms. They see this as a temporary 'liquidity' thing, but the problem goes much deeper than that. Hence, they have started along a dangerous path.

When , oh when, will they let this end?