(C) Regulators during markets' crisis

The world capital markets crisis, caused by the US exuberant consumerist, deepened by the low-quality mortgages is hard to be called recently originated. The US economy has been signaling weakness since the beginning of 2006. The crisis genesis lies in the diminishing loan requirements reflected in the so called no docs, NINJA, etc. loans. It is the financial markets regulations that have failed, not the capital market ones,… this time.

The regulatory bodies risk understandings lie on the academic obsolete standard normal distribution (SND) of the returns. On the same SND are based the regulatory risk requirements. Some contemporary research papers have shown that in periods of crisis the return distribution follows actually the so called Power Distribution. If I may paraphrase: During crisis the markets forget the SND, the standard deviation, the variance and all the Markowiz related ratios. In a liquidity crisis, the international diversification of a portfolio, when correlations reach one, is futile.

While discussing the restrictive regulation, one should not forget the reactive Sarbanes – Oxley Act, designed to answer the Enron’s fraud scandal. As of today there is little doubt that it offers more difficulties than solutions.

What the markets need, not only in hard times, but at any time is a practically working regulation, which is clearly understandable by market participants and regulators, rather than stricter regulation.