FT.com / In depth - How to tame the animal spirits

FT.com / In depth - How to tame the animal spirits:

"...policymakers have recognised that the financial system cannot continue to operate as an off-balance-sheet liability of the public sector, leaving the taxpayer to bear the cost of the clean-up after any catastrophe.....President Barack Obama declared in June that its “proposals would compel these firms to internalise the costs they could impose on society in the event of failure”.

A consensus is also growing on how to address the inherent pro-cyclicality of the system. A recurring characteristic of financial cycles is that good news fuels credit demand and supply. Asset prices rise in response, creating yet more collateral for more lending. The bursting of the resulting bubble then kills speculation and shrinks debt incurred in the boom.

During the latest bubble, pro-cyclicality was increased by flawed risk management and by securitisation,...leverage...as they shunted assets off the balance sheet. Leverage was also implicit in the structure of derivative instruments such as the swaps and options extensively used in banks’ own-account trading."