In God We Trust

There had been no warning sign of the coming collapse - until this year.

The tidal wave of withdrawals began after the market learned that Reserve Primary had been investing money in Lehman Brothers bonds, just $780 million to be precise. But the public suddenly realized that what looks like cash (money market funds are an alternative to cash deposits at banks) and quacks like cash may not actually be cash.

As the system crashes, some will crow that nothing is as safe as bank deposits. Indeed, there's no question that the American capital market failed, but it's an open question as to whether the banks have failed too. Don't forget that the sixth biggest bank in America, Washington Mutual, is begging for a Federal lifeline too.

There had been no warning sign of the coming collapse - until this year. No going-concern warnings, no proper disclosure, no outlook warnings from the credit rating agencies. The regulation and monitoring systems didn't peep. Investors had nobody to count on.

What about the regulators? Ostensibly, the meltdown originated in the wildest, least regulated segment of the financial system - the investment banks. At the regulated segment, the regular banks, the situation seems to be much better: We can hope that the tight, intrusive regulation of banks really proved its merit. But that isn't sure. The same intrusive regulation failed to uncover the trouble at AIG in time. What is sure is that the entire mechanism of regulation through "proper disclosure" bears reexamination. The unexpected collapse of the world's biggest investment banks proves that it doesn't work, period.

But you have to fume when you read another S&P statement from last week saying that it was reconsidering Lehman Brothers' rating - which could be upgraded, downgraded or left unchanged. The Israeli capital market was also treated to a wonder - a four-notch downgrade of local bonds on Wednesday, from AA to D (default), after the rater learned that the bank behind them was Lehman. Yet there had been concern about Lehman for months.

It has to be said: The model of the credit rating agencies has collapsed. Whether because of their unprofessionalism or inherent conflicts of interest, the fact that the agencies receive their pay from the companies they cover has bankrupted the system.

Maybe you can trust the new structure of financial supervision. In an era in which the Fed is rescuing insurance companies in distress, and when the fall of an investment bank threatens the survival of insurance companies and commercial banks as well, clearly the structural separation in Israel between the supervisor of the brokers (the Israel Securities Authority) and the supervisor of the institutional investors (the commissioner of capital markets, insurance and savings at the Finance Ministry) and the supervisor of the banks (the Bank of Israel) bears reexamination. Or, in a word, consolidation.

Maybe we can place our trust in a return to the good old concept of responsibility.

For example, the responsibility of an institutional investor to thoroughly inspect the quality of a security before buying it, without blindly relying on the recommendations of a credit rating agency, or opaque mathematical models to govern risk diversification.

Or, for another example, responsibility of a risk manager: Instead of merely diversifying risks, the manager should spend more time handling the risk itself. The root of evil in this financial meltdown is the fact that the people who lavished bad mortgage loans on the public weren't responsible for them. The bad loans were sold down the line through securitization. It turns out that when nobody takes responsibility for risk, risk bloats and bloats and reaches monstrous proportions.

At the end of the day, we have to place our faith in somebody, and unless responsibility is restored to the system, all we can do is place our faith in what it says on the dollar bill: In God we trust.