Corporate greed, moral hazard, lax oversight and foolhardy underwriting all contributed to the crisis in finance. Another factor, less useful for sloganeers but no less insidious, was the simple mispricing of risk.
When this large-scale mistake was revealed, much of the blame fell to the credit rating firms that were supposed to help measure risk, and to the credit-default swaps that were supposed to help manage it.
But despite all the handwringing over conflicts of interest in the assignment of ratings, despite all the concern about the shadowiness of a derivatives market with such systemic implications, little by way of concrete regulatory reform has emerged to prevent the problems from recurring.
The capital markets "must be empowered with the right information to detect risky behaviors and penalize companies before it's too late," said Leo Tilman, the president of the L.M. Tilman & Co. advisory firm and author of "Financial Darwinism: Create Value or Self-Destruct in a World of Risk." "So far, this is not happening on the necessary scale."
Without a fresh approach to gauging and handling risk, Tilman said, a financial system overhaul that redesigns the supervisory structure, tightens capital standards and lays out new responsibilities for boards and executives is only half complete.
Last fall, the credit derivatives market looked to be a large enough source of systemic risk to argue for a government bailout of American International Group Inc. But no one examining the market could really tell who was on the hook for what. This information gap also fueled grave concerns about the potential counter-party risks posed by the failure of Lehman Brothers.
Up until then most of what was known about the credit-default swaps market came from twice-yearly surveys by the International Swaps and Derivatives Association, a private group that had estimated the size of the market at a notional $62 trillion in late 2007.