Robert F. Engle: I agree with a lot of the points in Taleb's book, but...

Risk managers and investment bankers and actually, all kinds of investors took on more risk than they expected. So there was a failure of risk management. There was a failure to recognize how much risk there was in some of these securities that people bought.

Robert F. Engle

risk people bankers

There are a lot of ways that investment banking models work, but these risks are not internalized by the people that are taking them.

Robert F. Engle

banking risk people

The collateralized debt obligation, the CDO, is a structure which allows you to more or less continuously choose how much risk you want to take in a whole batch of securities. And the reason why they got us into so much trouble is that it's hard to figure out how much risk you really are taking.

Robert F. Engle

debt risk reason-why

When large companies take on risk, then they impose risks on the rest of the system. And these are systemic risks and these systemic risks we never used to think were really that important, but as soon as we recognize how the financial sector - the risks the financial sector takes on can impact the entire global economy, we realize that those risks needed to be controlled for the social good.

Robert F. Engle

impact risk thinking

So what is the role that credit default swaps can play in an economy? Well my feeling is that if these things actually will now be traded on either exchanges or some kind of central clearing, they are going to be a very good measure of the credit worthiness of different companies.

Robert F. Engle

different play feelings

I don't see what the alternative to risk management is. If it's just getting rid of the models and instead using the smart people who can figure it out? How do you train them? What do you teach them? Do you just put them in a cockpit and let them stumble for 10 years of their life and then after that they're good at it?

Robert F. Engle

smart people years

That is, many times we're not risking our own money, we're risking somebody else's money, or maybe that someone is going to back stop or downside, but we still get the upside.

Robert F. Engle

stills

If a lot of people feel like this company is undervalued and go out and buy the stock, the stock price will go up reflecting the higher value of this company. You might have information because you trade with them or because you've done some research on them.

Robert F. Engle

research done people

Well if you've got information about a company, or you believe that a company is undervalued, you can go out and buy their stock and you can make some profit on it.

Robert F. Engle

profit information believe

We're talking about should we increase taxes? Why not put a tax on carbon emissions. It would raise a lot of money, it would reduce the environmental damages in the future, it would solve so many problems, and it would be a much more constructive thing to do than to think about raising the income tax.

Robert F. Engle

carbon-emissions talking thinking

A lot of ambitious code has been written into the law for those and we will have to see if it actually works, if we have another example of a big financial institution going bankrupt.

Robert F. Engle

ambitious example law

I think we're fooling ourselves if we think that regulators are going to be able to outsmart the bankers. So, the task of designing regulatory reform is trying to make more or less foolproof regulation and that's one of the advantages of the systemic category.

Robert F. Engle

design trying thinking

I think global coordination is tremendously important. I hope we can see this happening through the G20 and through coordination of regulatory regimes around the world. I guess those are the main features of this bill that are important.

Robert F. Engle

important world thinking

I'd like to see a little more action on the energy side of things. I've been pushing for some kind of a carbon tax for years, and it seems to me we've had lots of opportunities to do it.

Robert F. Engle

pushing opportunity years

I think the credit default swaps can take the place of the rating agencies who really have missed the ball in this procedure and are quite conflicted by the way the ratings are paid for. So, I would like to see credit default swaps become an evermore important way of understanding credit risk in the economy.

Robert F. Engle

agency risk thinking

I don't think the idea of requiring these to be only sold to people who have already own the bonds, in other words, this naked position that the Germans have recently put into their financial regulation and has been discussed here. I don't think that makes any sense.

Robert F. Engle

people ideas thinking

If you pay attention to where your exposures are, you might tend up buying credit default swaps against a variety of people that you - companies that you deal with.

Robert F. Engle

buying attention people

Credit default swap gives you something to do. You can buy some credit default swaps from them to protect yourself against the bankruptcy of people who owe you money.

Robert F. Engle

credit giving people

I think what we need is better understanding of how to do risk analysis of a CDO, but that they still can perform a very valuable function because they can aggregate these risks and pass them around so that mortgages or other kinds of loans can be packaged and sold to investors all over the world, who in most times, would justify a small amount of each one.

Robert F. Engle

risk understanding thinking

Allowing short selling is allowing people to sell - instead of having to buy the stock and then sell it, which doesn't do much; allow them to sell it, and then buy it. In which case they can express that information and the idea is that you would get more accurate valuation of companies by letting people express both their positive information and their negative information through either long or short selling.

Robert F. Engle

long people ideas