The international credit crunch is not yet just economic history. There is still a lot of economic fallout to come, and some of it might not be too healthy at that, especially for the beleaguered taxpayers of the larger OECD countries. Ongoing currency realignments are an early signal of something a bit more profound going on, namely a shift in the balance of economic power and influence among the world’s major economic blocs, with a new set of economy and currency linkages. Big picture stuff this.

In the meantime, what now for the financial system? One thing is for sure, that the regulatory system will undergo yet another makeover. The catchword is ‘granularity’, which means a rule book running into thousands more prescriptive pages, with questionable effectiveness. The Holy Grail has to be a self regulating system, with some minimal rules in place to ensure that it remains so. That’s a big ask, but one aspect that receives fresh attention in our pages is the vital role of information, in order to ensure that risk is correctly priced; which it wasn’t in the subprime build up. The credit rating agencies have received a lot of stick in this respect, not least since investors and regulators had effectively endowed them as quality certifiers. However, a recent paper by Roger Bowden and Peter Posch argues that an optional registration system might reveal better signalling as to the fitness of credit ratings for the intended purpose. Find it in the Public Interest Papers page.

Still on the subprime crisis and its post mortems, the inherent tendency of a system based on credit default swaps to collapse is explored in another paper entitled Contingency and collapse in credit default swap networks, appearing on the Technical Papers page. The ultimate message is basically ‘no more AIG’s’, which means that CDS credit protection buying and selling must be done on an adequately diversified counterparty basis. A more general paper by Roger Bowden and Dawn Lorimer of Victoria University looks at some key systemic weaknesses revealed by the crisis, and what can be done about them. Crucial issues are the importance of certification, especially that provided by the credit ratings agencies, and whether credit derivatives are, or not, simply a deconstruction of commercial lending. Find the paper, entitled Credit securitisation and system stability, under the Public Interest Papers.

Then plan on getting a job as a risk manager in a regulatory agency or in a financial institution, for the bureaucrats will do well. The European Commission has drafted up a whole new set of deckchairs for a future Titanic: a Securities and Markets Authority (ESMA); a Banking Authority; Insurance and Occupational Pensions Authority; and a Systemic Risk Board, all under the umbrella of a European System of Financial Supervisors. As if 170,000 eurocrats weren’t already enough, even before you count the mob in the BIS at Zurich!

Adverse incentives created by the bonus culture among financial institutions have received a lot of recent exposure, especially now that several of the bailed out firms are well and truly back in the money, with mega bonuses once more on the cards. So far, however, reform proposals from the G20 and national regulators have not looked too convincing; more like an outburst of frustration than anything more lasting or effective. The trouble with ad hoc responses is that it’s simply too easy to get around them. A paper by Roger Bowden and Peter Posch argues that the principles governing the bonus pools need a lot of cleaning up if shareholders, and ultimately taxpayers, are not to be drowned in smelly effluent. The paper is entitled The bonus pool, mark to market and free cash flow: producer surplus and its vesting in the financial markets. Trading credit default swaps (CDS) are used to provide chapter and verse.

CDS were, of course, one of the villains of the piece in the credit crunch. To find out more about them and the crisis in general, the public interest papers have a downloadable pdf file of slides from a series of lectures given by Roger Bowden in 2008, updated to early 2009.

Talking of bureaucrats, one thing is for sure, that bureaucracy is the growth industry worldwide. It’s an old subject, dating from the days of Max Weber, Karl Marx, and Ludwig Von Mises, but it’s being bought up to date with the rise of what can be called performance bureaucracies. Words like ‘missions’, ‘goals’, ‘metrics’, ‘rubrics’, ‘mappings’, ‘granularity’ have entered the lexicon of burobabble. It’s all in the name of accountability, but as the old saying goes, ‘the road to hell is paved with good intentions’. A paper by Roger Bowden explains why the results are often so disastrous. Find it among the Technical Papers. The Introduction is worth a read.

The Public Interest Papers canvas further topical topics, covering things like infrastructure spending and how it is to be financed, in the process creating attractive annuitized investment products for the ‘oldies, who are in a parlous state now that interest rates have dropped.

Papers on sundry other topics can be found under Technical Papers, or alternatively the archive section for older papers, later versions of which have now been published in journals. For textbooks, see the Kiwicap Education page.