This Week’s Report: “Financial Crisis”

By Kenneth Jost, May 9, 2008

Did lax regulation cause a credit meltdown?

The flood of subprime mortgage defaults roiling the U.S. housing market is also feeding a worldwide credit crisis. Using complex computerized models, lenders have pooled credit instruments of all sorts – mortgages, credit-card debt, corporate and government bonds – for trading in lightly regulated financial markets. The banks, investment funds and other players that trade in these markets say that such “securitization” promotes economic liquidity by spreading and diversifying risk. Critics say the practice actually allows dubious loans to uncreditworthy customers to spread virus-like through worldwide financial markets. Investment banks in the United States and elsewhere are taking billion-dollar losses as they are forced to revalue their holdings. The U.S. Treasury Department has proposed a major overhaul of financial-markets regulation, but the sweeping plan offers little by way of immediate relief. In any event, any proposals for additional regulation will face stiff resistance from the financial community.

• Should the Federal Reserve be given more power to prevent financial crises?
• Should regulation of commercial banks and investment firms be tightened?
• Should the markets for credit derivatives be more closely regulated?

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