Financial markets need fixing

07.05.2010

What a day! Stocks in US tanked almost 10% across the board  for no reason. Greek issues were mentioned, but in fact Greek parliament passed belt tightening bills, so it was positive news. Later we found that it was a mistake, someone sold billions instead of millions of shares (or futures) and Procter& Gamble was mentioned as the company that was sold and fell more than 20%, Accenture was another company that took a beating. Then there were computer programs and automated trading, exactly as on Black Tuesday in 1987.

Ok, now comes the tricky part. How come a broker mistake leads to near 10% collapse of US stocks, which then leads to 10% collapse in CAC40 futures, and to 11% collapse in Nikkei250 futures. I know that we have a global economy, but there is something inherently wrong with the way financial markets function. Beacuse it is so similar to Black Tuesday, one should ask a person behind the Black Tuesday collapse. Richard Bookstaber, who spent 40 years as risk manager on Wall Street and who invented portfolio insurance which caused Black Tuesday wrote a book “A Deamon of our own design” that explains what went wrong. In short, we need to reduce leverage, simplify financial instruments and install circuit breakers.

So far record low interest rates encourage leverage, politicians plan more regulations which means even more complicated financial products, and as we saw today circuit breakers do not exist. So as a former central banker I have this little suggestion to my colleagues central bankers and regulators. Stop Basle 2 1/2 pep talk, stop repeating the same mistakes over and over again. Read Richard Bookstaber book. And European politicians should get necessary reforms on fast track, especially in PIIGS countries, but elsewhere as well.

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