Orderly Unwinding...

...Is the only way to avoid "Systemic Risk"

Barack Obama's financial regulatory plan unveiled this week will be the first step on the way to some badly needed regulations on Wall Street. It's a grand plan that is currently flawed in the sense that it doesn't attack the root cause of the credit crisis which is far too many useless complex financial products that few really understand. Leverage and risk taking was never the issue, it was the absence of financial risk control on complex derivatives that led to the crisis.

More regulation is not the answer, the right kind of regulation is. Self regulation is an oxymoron. You cant let the inmates run the asylum, then after the prison break, have the same inmates figure out what happened and fix it.

In the current financial crisis, the handling of failing firms was a messy
business. Indeed, the disjointed nature of these resolutions stoked the magnitude
of the crisis. The shock of Lehman Brothers bankruptcy would have
been less severe had the Street not expected the U.S. government to step in,
as it did with Bear Stearn's.

So there has to be resolution mechanism that allows for the orderly
resolution of any financial holding company whose failure might threaten the
stability of the financial system. Perception is far greater then realty. In realty there is no systemic risk or too big to fail, but the financial markets are run by human beings not SKYNET, and perception always trumps realty.

Bankruptcy is not suited for Financial Firms as we know from the Lehman debacle. Money is fungible. It doesn't lend itself to what we call reorganization, and today's financial firms are a maze of complex financial transactions that would take many months as in the case of AIG, which didn't even file for bankruptcy.

Because there was no method of deferring Lehman's counterparties
from exercising their remedial rights, hundreds of millions, maybe billions
were lost in its bankruptcy.

In the case of Lehman, their exposure was instantaneous under their contracts. Also the volatile nature of Lehmans exposure made holding those securities risky, so financial institutions want the option to immediately exercise their claims. But in
Lehman's case, that behavior which was the un-orderly unwinding of structured products, the liquidating of collateral, which led to prices spiraling down, making the markets more volatile. Quite simply as I have stated before, the markets "freaked" out because all indications was that Lehman was going to be sold or at worst a bailout was coming.

So who is tasked with this type of unwinding when companies get in trouble?

FDIC - Not a good place to start. They are already way over their heads trying to bailout depositors. That is what their mandate is. They don't have the trading expertise to handle this type of unwinding.

Treasury - Have some expertise, but not enough. Too many Wall Street people on board at the Treasury.

Federal Reserve Board - Conflict of Interest with direction of short rates, but have the best expertise in orderly liquidations.