Observe that the unregulated Credit Default Swap market is now working just fine, despite handling gigantic money flows, such as the failure of the Icelandic banks, that shake other markets, despite, or perhaps because of, the fact that more highly regulated markets have frozen up.
What went wrong in a short while ago in unregulated markets was that people in an unregulated market would look at a highly regulated participant in that unregulated market, such as AIG, and say “AAA rating, implicit government guarantee, and everything they do is examined by the regulators every month, obviously we can trust them completely”, and it turned out they could not.
Now that the assumption is that anything the regulators have a finger in is probably criminal, the unregulated credit default swap market is working fine.
As regulated financial markets have frozen up, the shadow banking system has taken up the slack. As regulators reach out to grasp the shadow banking system, it will no doubt swiftly become more shadowy.
Tags: AIG, shadow banking system