Possibly because they held back from selling their holdings because they were reluctant to go underweight a large component of an index they tracked (or were measured against). How to improve the performance of the asset management industry has been relatively neglected. That matters because in a market economy regulators should not be the first line of defence. Myopia Agency problems and incentives are not, however, the sole source of exuberance. I doubt that, in managing their banks, many bankers deliberately or even consciously drove the system over the cliff. Rather, like others, many were myopic about the risks in the system. Innovations in technology, the opening up of the world economy, new markets for transferring risk, and years of smooth growth, apparently attributable to better macroeconomic policy frameworks – all of this encouraged a sense that the world had become a safer place. High actual returns were extrapolated forward into required future returns. Add in to the mix, complexity obscuring the risks in the system as a whole. And, although UK policy rates were relatively high for a number of years, accommodative global monetary conditions fuelled a search for yield and underpinned confidence in resiliently liquid capital markets. 2 Distorted incentives, myopia, complexity, easy global monetary conditions: a heady mix. And a mix which the prevailing regulatory regime was singularly ill equipped to address, and in some respects had done much to create through inadequate capital requirements and an absence of liquidity requirements. In fact, a toxic mix.
When credit markets become overly exuberant, not only do the balance sheets of lenders become stretched, cheap credit leads borrowers to become over indebted,  2  2  See Tucker (2012), “National balance sheets and macro policy: lessons from the past”. BIS central bankers’ speeches  raising the probability of default. When defaults eventually pick up, a general awakening occurs, triggering mass deleveraging. This matters to debates about risk measurement and management. It is not simply that the models employed over recent years – notably Value-At-Risk – make assumptions, such as normally distributed returns, that are manifestly false. 3 It is not just a matter of finding better models, useful though that might be. The problem of exuberance is not simply one of lots of Black Swans. It is that the collective behaviour of market participants can generate the tail events that sow the seeds of the system’s destruction. It can breed swans. What the authorities are doing Given the complex mix of factors behind the crisis, it would be surprising if there were a single policy initiative that could make the system safer in future. The response is multi-dimensional. But you will be relieved to hear that at this point I am not going to summarise the whole of the international agenda. 4 I’m going to put to one side, for example, the panoply of measures being pursued internationally to simplify capital markets through greater use of central counterparties, and to avoid the systemic risks of banking activity simply relocating to shadow banks.