Looking For Risk In All The Wrong Places

In the demonological pantheon of the subprime crisis orthodoxy, the deepest level of hell are reserved for unscrupulous lenders. Uncreditworthy borrowers live at a slightly higher plane, nearby unvigiliant regulators. But the cant and caterwauling of the orthodox overlooks that much of the world was focused on quite different concerns before the mortgage bills for the ownership society came due.

Despite our best efforts, we’re still cursed with a memory that reaches past this morning’s headlines. We cannot forget that the problem with the CDO market was supposed to be insider trading instead of the weakness of the underlying financial assets. And it was meant to be hedge funds that posed a systemic risk to the financial system rather than our venerable investment banks, money centers, trading houses and brokerages. The great accounting scandal was backdated stock options rather than marked-to-model financial products. In short, all the heat and light generated by our various guardians was aimed in the wrong direction.

Yet so strongly held was the belief in the old orthodoxy that, if you listen closely or read the New York Times business section on Sunday, you can still hear those who wonder whether or not insider trading or hedge fund manipulation is somehow behind our current troubles. There is not much evidence of this, as SEC Commissioner Paul Atkins pointed out recently.

“Although we and our counterparts in government are monitoring and looking into the origins of the events of the last year, it does not seem that hedge funds were the origin of the subprime problems,” Atkins said. If anything, some hedge funds and their investors seem to have been the first casualties of the current debacle rather than the causes.

We don’t mean this as a criticism of those guardians. Rather, it seems to us an indication that the actual risks in our innovative financial world are difficult to detect and that none of our journalistic and political institutions are particularly well-adapted to early detection. What we need is modesty in forward looking, crisis-avoiding regulations—often we may be aiming our resources where they are not needed, and diverting our attention from where they are. As the fellows at Goldman used to say, since we can’t tell where things are going, we’d best stay nimble. There’s a very good chance that once again the orthodoxy is hunting down imaginary demons.