Market participants and also, arguably, prudential authorities underestimated the complementarities in the roles of different actors along the securitisation chain, the close interlinkages among financial markets and institutions, and the interplay between asset market and funding liquidity.Things get more interesting on page 40 again.

TABLE: So far bank losses seem to have peaked in the 2nd half of 2008. But all unofficial talk that reaches my ears focuses on the BIG whoppers still ahead of us. Especially corporate inter-linkages between banks and insurers may prove to be the major problems as accounting at insurers allows to hide losses much longer than on balance sheets of banks. And don't forget the yet unsolved $700 TRILLION problem of over-the-counter (OTC) derivatives. Search that figure yourself in the BIS report. Last time I checked it was "only" $600 TRILLION.

Here Some Color Before You Doze Away

Realizing that this blog post is in imminent danger to resemble the boring (but very readable) layout of the BIS original, here comes some color concerning the investment banking sector, whose limitless greed for ever larger bonuses for its employees is IMHO the root of all the problems we face today.

GRAPH: These charts are self-explaining and are in line with bankers bonuses over the past years. I notice that a decline in private risk securitization is now being substituted with more government debt business. As all other underwriting sectors have gone from boom to bust in the hands of pinstriped investment bankers I think this may forebode soon-to-happen disasters with public debt, i.e. the default of sovereigns. Check out this post about the pending risk of defaulting nations/fiat currencies.

Hedge Funds Going To Where They Came From: Nothing Left

Sorry for having water boarded you with too much black ink for the past couple of screens. You don't need to read page 48 and onwards to find out that 2008 was the year where the guys in front of an array of Bloomberg screens literally jumped out of the window together with most markets they had been betting on in the years before.

GRAPH: No need to say much here. Hedge funds were only riding the wave of markets and disappeared at the same velocity with which the markets of their choice went down. To be fair: Policy interventions limiting trading the short side did not leave them much room for survival in what turned out to be one of the worst years for all kinds of markets.

The last decade was not only marked by leveraging equity to the max (most institutions went down or were bailed out once leverage exceeded a level of 30, meaning banks, funds and all other players with access to easy money (thank you Alan Greenspan, thank you Jean-Claude Trichet, thank you Ben Bernanke) were playing with 30 times as much money as they actually had in the till.

A World Full of Debt Slaves

As if turning the better part into debt slaves by pushing mortgages on more or less everybody who could make it to a bank's office unaided was not enough banks were looking for still more business (and bonuses!) Saturated home markets left them only one choice: Expanding into new territories, kind of a financial recolonization of formerly dependent territories.

GRAPH: Having grazed off domestic markets, engulfing them in the highest debt levels of history, banks set the sail and started lending all over the world. Of course it is always easy to have the winnining lottery numbers on a Monday; but how the hell is it possible that a generation of whiz kids excelling in constructing sophisticated Excel sheets completely missed out on the unbending fact that growth has its limitations and every excess ends in a mutual cannibalization of market share?

Becoming a little tired to reprint the BIS explanations about the obvious mega-problems in the financial sector one is happy that after 55 pages the BIS begins to focus on what matters most: Financial crashes have always been the precursor of extended economic downturns.

Think South Sea Bubble, think France before the revolution in 1789, think Vienna stock exchange in the 70s of the 19th century (then the biggest stock market in the world) and then again in the late 1980s after Jim Rogers kissed it awake from a century long slumber.

When the easy money begins to dry up, so does the real economy (that is where all other people except bankers make their money!)

GRAPH: The real economy followed the downturn in the financial sector with a delay of about one year, proving again an old market rule that stock markets discount the future at a range between 12 and 18 months.

I absolutely disagree with this charts low showings of inflation. Inflation indexes are governments tools to keep the wages of public employees and the pensions of retirees as low as possible. This is not a science but simply a sophisticated way of lying in the face of the public.

Finally, Some Sort of Summary

Oh, on page 72 I find out I criticized the BIS for not coming up with some sort of executive briefing. Well, the black ink proves me wrong. Here we go:

The global financial crisis has led to an unprecedented recession accentuated by rapid declines in trade volumes, large employment cuts and a massive loss of confidence. How deep and prolonged the downturn will be is uncertain. In the industrial countries, there are some signs that the rapid pace of decline in spending witnessed since the fourth quarter of 2008 has started to ease. But a strong, sustained recovery in those countries could be difficult given attempts by households and financial firms to repair their balance sheets.
Nevertheless, substantial fiscal stimulus and exceptional monetary easing in many countries should help bring the recent contraction to an end. The policymakers’ task in the near term will be to ensure a sustained recovery. In the medium term, however, it will be to ensure that policies are adjusted sufficiently to maintain the stability of long-term inflation expectations.

Feeling that many readers will never have scrolled to this piece, I relieve the busy bee readers with another BIS conclusion beginning on page 136. Get this last dose of what I would not exactly call mythic wisdom of central bankers but a statement every economic and financial observer will agree with. In short: We need an instant reform but there are sooo many obstacles. Here's the longer BIS version:

We have no choice but to take up the challenge of first repairing and then reforming the international financial system, all the while cushioning the impact of the crisis on individuals’ ability to live productive lives. Efforts so far have fully engaged fiscal, monetary and prudential and regulatory authorities for nearly two years. The public resources devoted to economic stimulus and financial rescue have been staggering, approaching 5% of world GDP – more than anyone would have imagined even a year ago.
Recovery will come at some point, but there are major risks. First and foremost, policies must aid adjustment, not hinder it. That means moving away from leverage-led growth in industrial economies and export-led growth in emerging market economies. It means repairing the financial system quickly, persevering until the job of restructuring is complete. It means putting policy on a sustainable path by reducing spending and raising taxes as soon as stable growth returns. And it means the exit of central banks from the intermediation business as soon as financial institutions settle on their new business models and financial markets resume normal operations.
In the long term, addressing the broad failures revealed by the crisis and building a more resilient financial system require that we identify and mitigate systemic risk in all its guises. That, in turn, means organising financial instruments, markets and institutions into a robust system that will be closer to fail-safe than the one we have now: for instruments, a system that rates their safety, limits their availability and provides warnings about their suitability and risks; for markets, encouraging trading through central counterparties (CCPs) and exchanges, making clear the dangers of transacting elsewhere; and for
institutions, the comprehensive application of enhanced prudential standards combined with a system-wide perspective, beginning with the application of something like a systemic capital charge (SCC) and a countercyclical capital
charge (CCC).
Successfully promoting financial stability requires that everyone contribute. Monetary policymakers must take better account of asset price and credit booms. Fiscal policymakers must ensure that their own actions are consistent with medium-term fiscal discipline and long-term sustainability. And regulators and supervisors must adopt a macroprudential perspective, worrying at least as much about the stability of the system as a whole as they do about the viability of an individual institution. An encompassing policy framework with observable objectives and implementable tools is at an unfortunately
early stage of development. But the suggestions made here and elsewhere are a start. The work will have to be coordinated internationally. In particular, institutions with expertise in the field – including the Basel-based standard-setting committees and the Financial Stability Board – will need to play a leading role in making such a framework operational. This is going to be a long and complex task, but we have no choice. It has to be done.

As in most of my past 600+ posts I disagree with this official attitude that has landedus where we are. It would be maybe of help if all insiders REALLY read David Ricardo and Adam Smith and then follow these centuries old guide lines for free markets. My two cents can be found here and will be extended in the future.