Shadow Banking - What Needs To Be Done Continued

This is a paper written by Gary Gorton of Yale University.

This is the same Gary Gorton that created the Quantitative Models that AIG used to price CDS Risk.

I am not here to get on Mr. Gorton, he is a lot smarter then me, and he makes some interesting and thought provoking points, but some of his points and suggestions are extremely dangerous.

At the end of the day both Mr. Gorton and I are realists, we understand that the system needs credit, and that potentially dangerous suggestions need to be made to keep the economy afloat.

In the the absence of any whole sale changes that need to be made to fix the rotten to the core system, these suggestions are dangerous but they are the only ones politically feasible.

In America (Politically Feasibility = Realty)

The Summary of Mr. Gortons recommendations:

1. Senior tranches of securitizations of approved asset classes should be insured by the government.

I spoke about this very briefly yesterday. Only the most senior, highest independently rated asset classes should be insured.

This potentially is very dangerous, but our economy needs trillions in new credit to be rolled every year, otherwise the patient dies.

tradersutra.blogspot.com/2009/07/shadow-banking-for-dummies.html

2. The government must supervise and examine "banks," i.e., securitizations, rather than rely on ratings agencies. That is, the choices of asset class, portfolio, and tranching must be overseen be examiners.

The single best idea here in this paper is the outright removal of the Ratings Agencies, but again...

...This is very difficult to do as securitization is very complex and hard to figure out. Does the government have the horses to do this?

You saw how the SEC dropped the ball in the Madoff scandal, how can we make sure these guys are competent?

3. Entry into securitization should be limited, and any firm that enters is deemed a "bank" and subject to supervision.

Again, supervision is only good if its done by competent people.

Anyway, have fun reading this.

Slapped In The Face. The Banking Panic Of 2007