Christophe

The points you raise are quite interesting.
I think that conflicts of interest and loss of confidence could be avoided if we prevented market makers from marketing their unhedgeable risks to other investors. Here, this would have prevented Goldman from dealing with Paulson in the first place as the risk they took (long position in the CDO) was not traded in a liquid market. Of course, this radical proposal would be an obstacle to the market making activity in investment banks and insurance companies as it would prevent them from transferring such risks as dividend or correlation risks to investors. But the benefits could be important for society as a whole: more trust, less conflicts of interest, less moral hazard (as
the new risks created will have to be borne by the entity that originates and (hopefully) understands them).
This proposal has to be included in a broader set of reforms whose goal would be to better circumscribe and separate banking/insurance activities (market making, advisory and prop trading).
Yours sincerely
Steve Ohana
Professor of Finance at ESCP Europe

There’s no crying in baseball. But that does not mean that there’s no cheating or that cheating should not be punished for the benefit of the game. The SEC represents the markets, not the victims of any particular scam. The foolishness of the victim says nothing about the thief.

But I think Mario ignores the subjective nature of what ACA and IKB do for a living. ACA was acting as an insurer of the portfolio. Yes, it can inspect the property, but it can also legitimately inquire into matters of adverse selection. Does the insured have an insurable interest? Is guy helping to select the portfolio (WHY was JP invited to that table?) long or short the portfolio? Are we working together to select the best reference portfolio, or are we negotiating one? These are matters that insurance underwriters routinely consider to bolster their confidence in their own assessment. Non-insurance types idealize the process as based simply on the merits of the risk, but insurers know better than to rely entirely on their judgment of the implications of who is buying the insurance and why.

As regards IKB, we are talking about a foreign investor who came to a gilt-edged investment bank, demanded that an independent agent select the portfolio of US RMBS, and further demanded that their tranches be rated AAA. If that’s not enough, who needs investment banks, selection agents, and ratings agencies? And what foreign entity will want to hold dollars if the US financial services industry cannot be trusted to deliver good paper when asked – and paid! – to do so?