Quotable: Steve Coll on Credit Default Swaps
Writing in his blog “Think Tank” on The New Yorker’s website, staff writer Steve Coll talks about the consequences of the “shadow banking system,” and how its frightening lack of transparency contributes to the financial crisis:
If the housing bubble had inflated entirely inside a transparent, well-regulated financial system, its end might have been painful, as the tech bust was, but it probably would not have been unusually consequential. The problem, however, was that the bubble inflated inside both the old regulatory system and, simultaneously, inside a new financing system that grew up during the Bush Administration outside of all government scrutiny.
In the current global panic, unprecedented in fifty years, it is common to say that the madness of crowds has taken over. It is certainly true that we should be fearful of fear itself, since panic has practical economic consequences. Prices, for example, speed down faster than they would otherwise, which then causes more panicked selling by leveraged investors. Fearful consumers sit on their wallets, hurting businesses that might otherwise be healthy, and so on. At the same time, it is wrong to blame crowds for this current panic. In many ways investors are reacting rationally to the fact that critical information about the financial markets–the sort of information that New Deal-originated regulatory architecture was supposed to make routinely transparent–is simply not available.
People don’t generally panic in the sunshine. They panic in the dark. And we are in the dark about what assets and liabilities are truly held in what has been properly labeled the “shadow banking system”–the global aggregation of hedge funds, privately placed debt securities, and the hedging or insurance contracts known as credit default swaps. By some accounts, the value of assets held in this shadow system is as large or larger than then value of the assets held in the formal, regulated banking system. But nobody really knows, as there is no transparent market for many of the securities of concern, and no systematic disclosure of assets and liabilities to government regulators–not here, not in Europe, and not in Asia, either.
