©OECD Observer No. 279, May 2010
Time for new rules?
One insight worth mentioning is that it is entirely rational for lenders (and insurance companies) to cut prices and underwriting standards to increase market share in good times. That is the way to make money. But it is important to understand the concept of insurable versus uninsurable risks. Credit default swaps to a significant extent, aim to protect investors from systemic risk. This is not an insurable risk. So swaps are really an abuse of strong balance sheets (or outright fraud if not backed by strong balance sheets). So I think it would be wise to simply outlaw them. It is hard enough to price risk first hand. Trying to price risk second or third hand is simply impossible. The failure of ratings agencies and the willingness to peddle trash as treasure conclusively prove that there are no fixes for transactions that simply can’t be priced by the parties involved.
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