Monday, December 22, 2008

Bank 'did not understand crisis'

Bank of England 'did not understand crisis', said its deputy Governor, Sir John Gieve.

That's a bit like your pilot saying he does not understand how to land his plane in fog. I mean, it couldn't happen, could it?

Still, finance is a complex business, and we cannot expect people to understand what is going on just because they are paid hundreds of thousands of pounds to sit on committees which govern the Bank of England. Sir John is a Civil Servant, not a bean counter.

As Galbraith said, "The process by which money is created is so simple that the mind is repelled".


Anonymous said...

Here is something interesting from the Evening Standard-

'Legendary American investor Warren Buffett has a gift for cutting through the rubbish to express risks and problems with great clarity - which is probably one reason why he is so good at what he does. Interviewed recently by the US business magazine Fortune, he explained as follows why it was that purchasers of the credit derivatives at the heart of the subprime meltdown had no understanding of what they were buying.

The prospectus for a mortgage-backed security - a pool of several thousand mortgages, and the starting-block for a CDO - would run to about 300 pages, he said. This pool would be divided into perhaps 30 tranches, and one of these horizontal slices would be combined with a similar tranche from 50 other mortgage pools to create one CDO.

To understand what is in that CDO, the investor now has 50 prospectuses of 300 pages to read - in other words, 15,000 pages. A further derivative, the CDO squared, repeated the trick. Using CDOs as the building block, it took tranches from 50 CDOs to create one CDO squared. Therefore, to understand what a CDO squared involved that investor had to read 750,000 pages - which of course absolutely no one did.

For the record, there were also a few products called CDO cubed. The under-lying prospectuses for them would run to 37.5 million pages.'

DocRichard said...

Thanks JMac, very interesting. And I thought that the main skill of accountants and solicitors was their ability to read the small print...