Professor Avinash Persaud, who shot to fame in the late 1990s by predicting the Russian devaluation crisis four months before it happened, has criticized the credit derivatives market for merely pushing credit risk into the insurance sector, and not actually reducing the level of systemic risk in the financial markets, as its boosters often contend.
Persaud, an investment director at GAM London, chairman of Intelligence Capital Advisors, and Mercer memorial Chair in Commerce at Gresham College in London, said because the insurance sector has started marking-to-market exposures in the same way as banks, it has not made a significant difference to the overall level of risk. Persaud lays some of the blame at the regulators' doors. He thinks regulators have exacerbated the situation by trying to impose a mark-to-market framework across the financial community through such methods as International Accounting Standards and also by not spelling out to asset managers that they need to take a long-term view.
Persaud's theory is, "risks are not reduced by being spread if all [the risk takers] behave in the same way. Diversity in methods, not in name plates, leads to the reduction of risks," he added.
The professor acknowledges the banking sector has emerged relatively unscathed from one of the harshest credit crunches, but he argues looking at banking as a test of financial market health is outdated.
Persaud argues the insurance sector is now sitting on the risk. Because insurers are marking positions to market, they will hedge volatility looking to sell exposure when the price falls. This could lead to disaster. "When falling markets are met by hedgers and not bargain hunters, black holes develop," he prophesied.
The solution, argues Persaud, is for insurance companies and asset managers to start acting in the traditional way, which includes taking a long-term view and accrual accounting. "We need high and uncommon standards," he concluded.