Saturday, August 18, 2007

The Most Intelligent Commentary on Sub-prime "crisis"

Here is the bottomline:

The deeper moral is simple. Financial markets exist to do risky things. The more risk they take, the higher the (expected) returns. You can use regulation to squeeze risk out of a segment of the market, say banks, but you don’t eliminate the risk, you just move it elsewhere. New segments, say hedge funds, emerge to take over the risk and the high (expected) returns that go with it.

The problem is that little is known of the new segment and its players, so the armies of regulators and supervisors that protect us look in the wrong direction because they don’t know where to look. There has been much talk about regulating the hedge funds; it might happen, so the game will move elsewhere.

The only way to eliminate financial crises is to fully eliminate risk. Kim Jung Il knows how; eliminate financial institutions. But that means no (expected) returns. (my emphasis)

The post is witty, well written and mostly jargon free. It tackles the sub-prime issue at a conceptual level that is hard to find in your daily paper. No, you won't even find it in your copy of FT or WSJ. Read the whole thing here.

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