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Raising the right alarms on risk

Here is a very interesting and insightful Fortune Magazine article from a fellow MIT Sloan alum, and MIT Sloan Professor Andrew Lo. In it, he discusses the goods and bads of financial reform, how to prepare for calamities to come, and the “holy grail” of good regulation. Check it out.


FORTUNE — When the rest of the world was busy buying second homes with no money down, MIT professor Andrew Lo was busy beating the drum over a coming financial crisis. For a while, he was playing to an empty room, but now his prescience makes him a voice of authority as we deal with the meltdown and its aftermath.

Fortune recently spoke with Lo about the goods and bads of financial reform, how to prepare for calamities to come, and the “holy grail” of good regulation.

Edited excerpts of the conversation are below.

How far along are we in understanding the causes of the financial crisis?

We’re somewhere between the third and fourth inning. The Financial Crisis Inquiry Commission hasn’t even filed its report yet. We are quite a ways away form a detailed understanding of all the myriad things that caused the crisis.

With that in mind, is Congress moving too quickly to enact sweeping reform?

I’m of two minds regarding the legislation. On the one hand I think that Rahm Emanuel was right when he said, “a crisis is a terrible thing to waste.” I think there are some positive elements of the bill as proposed and we should be thankful. But we still don’t know about a number of important aspects of the crisis. There’s great potential of unintended consequences. There are some of the causes of the crisis that this bill ignores.

What do you like about the existing plan?

The idea of creating an Office of Financial Research is terrific. The OFR is mandated to gather all the data to measure systemic risk, and also have subpoena power, which is crucial. And they’re also independent, even though they are housed in Treasury. So they are free to criticize the Treasury.

The other great idea is the exchanges for things like credit default swaps. And the idea of the Volcker rule, as proposed, could be quite positive. Banks that rely on customer deposits should not be taking on these large risks. If the government is going to be on the hook for providing backstops, I think it has every right on behalf of taxpayers to limit the risks they could take. But the devil is really in the details here.



Written by David Frederick

June 23, 2010 at 2:59 PM

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