But because much of their assets are stock shares, hedgefunds, future buying options, composite debt letters, bonds and other kinds of instruments, which do not have any kind of fixed value even for a few days, there is often no real way you could control on a daily basis that the bank has a safe 20% liquidity or whatever.
To some extent yes, but:
Banks are required to hold a minimum level of "tier 1 capital"
, in other words they're required to hold a certain level of relatively low-risk assets (cash, government bonds) relative to risky assets (stocks and derivatives).
On top of this, banks almost universally use some kind of value at risk
model to figure out what kind of losses they're exposed to in all the risky investments (like stocks and derivatives) they're involved in. VAR is basically asking "if the worst case scenario happens tomorrow, how much do we stand to lose?". If their VAR is high, banks will tend to deleverage and recapitalize (in other words, sell risky assets and buy safer ones). They also tend to hedge their bets in various ways.
You do not get promoted or recognized for standing up and saying "these shares you're hyping up, they're trash, and these guys you're doing business with are rogues" or "those people will never be able to pay back" - more likely you do get fired or sneered at, or will see your salary stagnating. Banks and trader gangs have their pet ideas just like any environment; cold and rational weighing of risks is not enough to make a career.
There is truth to this - compensation on Wall Street is tied to short term performance and generally not well adjusted for risk - but there are a lot of people who were sounding alarms about subprime mortgages and European sovereign debt that banks are paying more attention to now too. Banks lost money there and they don't like losing money. After the UBS scandal last week people are looking at risk management a lot more closely too.
It does make me wonder if banking is something a sufficiently transparent government would handle better, though. The alternative is to dismember all of the big banks again, so that if one gets stupid we can let them die.
No one likes bankers except bankers, and bankers truly love themselves.
The thing is that banking is about deciding where the vast majority of investment goes in the economy, and putting all of that in the hands of government is really socialism on the level of the Soviets. The government would be deciding where investment goes, with all the cronyism and corruption that comes with it. I don't defend the catastrophes the financial system has wrought over the last several years, but on the other hand I think that government control may be an even worse solution.
I prefer a middle ground - stronger and smarter regulation. I think Dodd-Frank was a good step in that direction, for instance.
(history of the subprime loan)
I agree with your assessment of the crisis and how it came about, but I'd like to opine about what the banks did.
The banks started creating CDOs that transformed subprime loans into low-risk loans (through tranching). The basic idea of a CDO is not a bad one - it creates liquidity, it allows banks to move risk around, it creates a market where one otherwise would not have existed. With CDOs people can get loans to buy homes that would otherwise not be possible.
If they had gauged the risk correctly, there would have been no problem. In fact, there would have been millions of Americans in homes that otherwise wouldn't have had them - they couldn't have gotten the loans if banks hadn't been able to trade these mortgages.
The key problem was that banks and credit ratings agencies failed to assess the risk correctly. They should have been much more conservative. Unfounded assumptions about the prices of homes were made.
So the point I want to make is that we shouldn't blame derivatives like CDOs for the problem. There is nothing fundamentally wrong with them. We should blame overleveraging and a failure of risk management for it.