Thus as documented elsewhere in detail once a

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Unformatted text preview: ing to be explainable by moral hazard, it must have allowed commercial banks to pile on more risk. However, whether, on balance, commercial banks ended up shedding or piling risk through securitization is not entirely clear, albeit some evidence seems to militate in favor of the latter.40 As intended by the early promoters of securitization, the sale of mortgage‐backed securities to investment banks should in and of itself, have reduced (not increased) commercial banks’ riskiness. In reality, however, much of the risk was never really divested away. Instead, commercial banks repurchased good chunks of the instruments they sold, for reputational as well as business continuity reasons, and remained committed to support investment banks through their back‐stop liquidity facilities (they were lenders of first resort to capital markets players). Moreover, they generally retained the more risky assets (or the more risky tranches) while shedding away the less risky ones.41 At the same time, they moved down the credit market to take on new and arguably higher risks associated with consumer, mortgage, and SME lending. They also accumulated more risk by engaging in widespread rating arbitrage (shopping for the most favorable ratings).42 Moreover, even if one believes that banks did accumulate more risk, it does not necessarily follow that this was induced by moral hazard. Indeed, commercial banks could have genuinely bought the risk under the presumption that it was safe for them to store it (they perceived the regulations to be too tight and their capital more than enough to cover the associated risks). Under this interpretation, to which we will come back under the externalities paradigm, commercial banks ventured into new markets and new instruments simply because they had a comparative advantage in doing so. Perhaps more importantly, the main piece of the puzzle that does not quite fit this paradigm is the blatant asymmetry between the smart ones who are alleged to have consciously caused havoc and all the rest of the financial market participants who were not paying attention. In particular, why did the markets (informed investors and shareholders) fail to discipline financial intermediaries? In the end, many investors surely got it wrong and lost tons of money; a multitude of bank shareholders got wiped out; and many managers likely have had second thoughts about having played so eagerly the alpha card. In this context, supervisors must surely also be thinking that it is unfair to treat them as if they were the only ones asleep at the wheel. The moral hazard story inherently requires a strong agency problem, caused either by high enforcement costs or deep crevices of information asymmetry. Arguably, principals(shareholders and large investors) lacked the incentives or regulatory tools that might have helped them align the actions of their agents (managers). However, it is difficult to believe that principals would not have taken early disciplinary action, if only by voting with their feet, had they really understood the risks agents were taking. Thus, setting aside the problem fac...
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This document was uploaded on 11/14/2013.

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