from Alan Binder at the New York Times, Financial Collapse: A 10-Step Recovery Plan, 1/19/13.

Excerpts:

5. Use Less Leverage

Excessive leverage — otherwise known as over-borrowing — was one of the chief foundations of the house of cards that collapsed so violently in 2008. Overpaid investment “geniuses” used leverage to manufacture extraordinary returns out of ordinary investments. Bankers and investors (not to mention home buyers) deluded themselves into thinking they could earn high returns without assuming big risks. But leverage is like alcohol: a little bit has health benefits, but too much can kill you. The banks’ near-death experiences, plus preparation for higher capital requirements to come, are temporarily keeping them sober. But watch for the binge drinking to return.

6. Keep It Simple, Stupid

Modern finance profits from complexity, because befuddled customers are more profitable ones. But do all those fancy financial instruments actually do the economy any good? Paul A. Volcker, the former Fed chairman, once said the A.T.M. was the only beneficial financial innovation in the recent past. He may have exaggerated, but he had a point. Who needs credit default swaps on collateralized debt obligations, and other such concoctions?

7. Standardize Derivatives and Trade Them on Exchanges

Derivatives acquired a bad name in the crisis. But if they are straightforward, transparent, well collateralized, traded in liquid markets by well-capitalized counterparties and sensibly regulated, derivatives can help investors hedge risks. It is the customized, opaque, “over the counter” derivatives that are the most dangerous — and the ones more likely to serve the interests of the dealers than their customers. Dodd-Frank pushed some derivatives toward greater standardization and transparent trading on exchanges, but not enough. The industry is pushing to keep more derivatives trading out of the sunshine.

8. Keep Things on the Balance Sheet

Before the crisis, some banks took important financial activities off their balance sheets to hide how much leverage they had. But the joke was on them. The crisis revealed that some chief executives were only dimly aware of the off-balance-sheet entities their banks held. These “masters of the universe” hadn’t mastered their own books. Dodd-Frank specifies that “capital requirements shall take into account any off-balance-sheet activities of the company.” That’s a welcome step toward making off-balance-sheet entities safe and rare. Now regulators must make the rule work.

9. Fix Perverse Compensation

Offering traders monumental rewards for success, but a mere slap on the wrist for failure, encourages them to take excessive risks. Chief executives and corporate directors should “claw back” pay when putative gains turn into losses. If they don’t, we may need the heavy hand of government to do it.

 

HKO

Read the whole article. Tips to Neil Cullinham

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