My concern is that the current financial system is based on a pile of shit faith. The Fed is the church of the 21^st century. That said, I’m in the market so I must still have some faith. I don’t expect a worldwide depression; just a recession. I do think financial engineering will have to be rethought. Consider that Basel II’s foundation is built on rating agency’s’ ratings and quantitative risk models. Checkout this or read my summary below of it of AAA rated bond insurance company MBIA.

1. Impact of losses measured on post-tax basis

• Should be $5.13B (assuming a tax rate of 38%), not $3.18B

2. Covenant Violations and Loss of Access to Liquidity Facilities

• Lose access to $500M

3. Loss Estimates Must Incorporate Reinsured Exposures

• $42B ($21.5B is CDOs of ABS or CLO/CBOs) of reinsurance from Channel Re should be put back on the balance sheet
  
• $11B from Ram Re
  
• MBIA reinsures Ambac, and Ambac reinsures MBIA

4. Bond Insurers’ Investment Portfolios are Riskier Than They Appear

• Portfolios include substantial amount of bonds guaranteed by bond insurer itself or other bond insurers

5. Commercial Mortgage Backed Securities (CMBS) Problems Ignored

• MBIA insured $43B net par of CMBS securities (vast majority underwritten in 2006 & 2007)
  

6. Claims-Paying Resources Definition Overstates Capital Available to Pay Claims

• Include present value of future premiums discounted at extremely low discount rates (~5%)
  
  • Ignore defaults or prepayments
    
  • Purchasers of secondary market guarantees likely to terminate periodic premium payments
    
  • No provision for overhead, remediation, legal, or other costs required to run the business

7. Holding Company Liquidity Risk

• The holding company has $45B of derivative obligations (currency, interest-rate, + CDS)
  
• Holding company legal expenses and litigation claims
  
• Holding company downgrade scenarios
  

Historically, AAA corporate bonds have performed up to 80x worse (based on defaults) than A muni bonds. Care to guess how AAA CDO bonds performance compares? So ratings by themselves are often relatively worthless. Now if I was to guess what the quant risk models are based on….