“It has been two years since Lehman Brothers fell and almost brought down the entire financial system. Despite the financial pain uncorked by the collapse the collapse, adequate controls are not in place – global systematic risk remains and the likelihood of another Lehman-like crash is high.”

Contact Mark Williams, 617-358-2789, williams@bu.edu

“The Basel agreement reflects two troubling phenomena: first, international acquiescence to the continued existence of ‘t00 big to fail’ banks; and second, the exultation of capital over risk management as the primary supervisory tool.”

Contact Cornelius Hurley at ckhurley@bu.edu, 617-353,5427 or on Twitter @ckhurley

“The dangers and weaknesses in the credit rating agency process remain, structurally, but I think we can afford not addressing them in current legislative proposals.  At its simplest, the Congress already has too much on its plate with currently proposed financial regulation legislation to also tackle rating agencies just now.”

Contact Robert Bench, 617-353-5428, bobbench@bu.edu

“The answer to the ‘too big to fail’ high-wire act does not lie in removing the government’s capacity to cope with these institutions in a crisis. It lies in removing the financial incentives for becoming TBTF in the first instance.”

Contact Cornelius Hurley, 617-353-5427, ckhurley@bu.edu

“We are in a new era of financial reform and it’s clear that Wall Street’s ‘heads I win, tails I don’t lose’ mindset is going to be challenged by the White House, the pay czar, and ordinary Americans.”

Contact James Post, 617-353-4162, jepost@bu.edu

Williams says Bernanke missed the point.

“The Fed took its eye off the ball.  The regulatory framework that oversees our banks cannot be repaired until the most important regulator, the Fed, completes a thorough internal assessment of how they missed the real estate bubble which was the primary driver of our current recession.”

Frankel says consolidating regulatory authority would be a mistake.

“In the 1930s we avoided ‘too-big-to-fail government” by splitting the regulation of banking, insurance, and markets.  Now there is a proposal to combine them into one huge regulatory system.  I hope that both financial intermediaries and their regulators never again acquire as much power as they do now, and I hope we do not strictly regulate the entire system under one roof.”

School of Law Professor Susan Koniak, in a New York Times op-ed, says the Obama mortgage bailout plan won’t stop foreclosures because it concentrates on reducing interest payments, not reducing principal - a waste of taxpayer money that won’t fix the problem.

“For subprime and other non-prime loans, which acount for more than half of all foreclosures, the best thing to do for the homeowners and for the bondholders is to write down principal far enough so that each homeowner will have equity in his house and thus an incentive to pay and not default again down the line.  This is also best for taxpayers, who now effectively guarantee the securities linked to these mortgages because of the various deals we’ve made to support the banks.”

Waistlines are expanding as worries about the economy worsen, according to doctors, dietians and trainers in a Forbes.com story last week. Caroline Apovian, M.D., director of the Center for Nutrition and Weight Management and director of clinical research for the Obesity Center, both at Boston Medical Center, has seen the eating habits of her patients worsen.

“My patients used to be able to keep their weight under control by eating lots of fresh produce and lean protein,” said Dr. Apovian. “Now they can’t afford these things. As a result, they’re seeing the numbers on the scale creep up, along with their blood pressure, blood sugar and cholesterol.” 

School of Management finance Professor Mark Williams, a former Federal Reserve Bank examiner, feels strongly that the Credit Default Swap (CDS) market definitely shares some blame, but it isn’t justified to make it the latest scapegoat responsible for the economic meltdown.  Nonetheless, there is a crying need for regulation of the CDS market and creation of a strong CDS clearinghouse as a direct response to a real and growing financial danger.

CDS Market: Contributor, not Cause

By Mark T. Williams

The Credit Default Swap market shares some blame, but it isn’t justified to make it the Beltway’s latest scapegoat responsible for the economic meltdown.  There is, however, a need for its regulation and a strong CDS clearinghouse as a direct response to a real and growing danger.  One or two more defaults from CDS protection sellers could roil this already fragile market. 

The fact that the CDS market continues to function  is not proof alone that it is healthy and doesn’t need fixing.  Unfortunately, today’s financial crisis can trace its roots back to elevated risk-taking fueled by CDS.  The real question is, Would banks have still lost over $1 trillion in the current credit debacle if the CDS market had not existed? 

In less than 10 years, this market has grown from a tiny, strictly inter-bank market for hedging credit risk to a highly speculative market with a multitude of counterparties.  This growth is understandable, as CDS created a cheaper form of betting on company defaults without requiring sizable cash outlays.  Since 1997, this market has grown from under $1 trillion to $60 trillion.  Although the way the market uses these product today has changed dramatically, the same unregulated OTC trading structure has remained. 

While it is true that the net CDS payouts of over $6 billion, triggered by the Lehman Brothers bankruptcy, was relatively smooth, it is important to realize that this represented only one credit shock.  Would the CDS market have continued to function if AIG, Freddie Mac, and Bear Stearns had not been rescued? 

The weakness of the existing CDS market is that a few players dominated the field, and as long as their credit stayed strong, the market also was strong.  Once creditworthiness declined, investor confidence quickly eroded. 

What would happen to this market if corporate defaults by larger CDS protection sellers (such as Citigroup, Bank of America or Morgan Stanley) defaulted?  The fact that this critical question cannot be answered with absolute certainty suggests that we need to exercise caution and require more, not less, reporting and regulatory oversight.  A centralized CDS clearinghouse would also help to alleviate credit fears by spreading risk among a broader participant group. 

While still standing, the CDS market is wobbly.  Investor confidence is waning and many participants, including hedge funds, have been forced to unwind and deleverage their holdings.  Although individual credit events haven’t knocked out the CDS market yet, there is much credit uncertainty as the economy continues to deteriorate.  As a safeguard, putting in place smart regulation and a clearinghouse will help backstop credit concerns and restore investor confidence.  Without such needed changes, as more investors flee this market, CDS will be the next domino to fall.

(Mark T. Williams is a finance professor at Boston University’s School of Management and former Federal Reserve Bank examiner.)

In response to last week’s signed letter by economists, sent to congressional leaders opposing the government bailout plan, a group of academic economists lead by Boston University’s Laurence Kotlikoff, have signed a letter in support of the plan before Congress dealing with the financial crisis.

Below is that letter, addressed to the Speaker of the House of Representatives and the President pro tempore of the Senate, along with the names and affiliations of those in favor of the plan.

ECONOMISTS PEN LETTER TO CONGRESS IN SUPPORT OF BAILOUT PLAN