Steve Waldman has a corker of a blog entry today, blaming a large part of the present crisis on "investors' childlike demand for safety". It's a very powerful insight.

Think of the enormous emerging-market central bank reserves that everyone was so worried about for the past few years, and which caused the global imbalances which are now only slowly beginning to unwind. Substantially all of them were invested in triple-A paper -- either Treasury bonds or Agencies. But there were private investors too who wanted the highest possible level of safety; with Treasuries all snapped up by the Chinese, they developed an insatiable appetite for structured products. MBSs, CDOs, ARSs, CPDOs: it didn't matter what they stood for, the only thing that mattered was AAA.

To put it another way, the problem wasn't high-risk financial products, it was low-risk financial products.

The housing boom was born less from inordinate risk-taking than from the unwillingness of investors to take and bear considered risks. Agencies, asset-backed securities, it was all just AAA paper. It was "safe", so who cared what it was funding?

There is a case to be made that small bank depositors should not have to worry about whether they'll be able to get their money back: hence the FDIC. But beyond that, Steve is surely right that there are altogether too many people, including a large number of enormous institutional investors, who fetishize safety to the point at which they don't want to bear any risk at all. But capitalism doesn't work without risk. If the providers of capital aren't willing to take risk, the system breaks.

Here's a heretical idea: What if the USA losing its triple-A credit rating wasn't the worst thing that could happen right now, but rather the best? What if we got rid of the idea entirely that there is any such thing as a "risk-free rate of return", and came to realise that all investments involve risk? Come on, Moody's; have a go, S&P, do your worst! Maybe then investors will start doing their own homework when it comes to risk and reward, rather than blindly throwing money at anything with a "risk-free" or "triple-A" label.

The problem with auction-rate securities was maybe this: that stockbrokers felt a huge amount of pressure to reassure a bunch of investors with, typically, six-figure sums of money to invest, that their money was perfectly safe and perfectly liquid. There's no such thing, and frankly people should stop being so cavalier about money-market accounts as well. If you've got lots of money, good for you. Now go and invest it sensibly. Don't ask for zero risk. That way lies trouble.

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Felix Salmon

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