Why the global financial crisis could happen again

For the 450-strong crowd of hedge fund dealers that gathered together to eat, drink and be merry at the Star casino in Sydney for the annual hedge funds rock and awards bash, the anniversary of the collapse of Lehman Brothers was a fading memory.

The celebration was exquisitely timed. As Australia's brightest "hedgies" reflected on their achievements on September 12, millions of investors were quietly mourning the Lehman Brothers collapse on September 15 five years earlier.

Hedge funds were demonised during the global financial crisis for the damage they caused global equities markets by short-selling stock and in some cases spreading rumours to make a quick buck. "We are like goldfish," a former hedge fund manager famously said a year after the crisis hit. "We swim once around our bowl, and when we complete the circle everything looks new."

It is a scary thought. But it seems the more things change, the more they stay the same. The financial markets are heading back to pre-crisis levels, private equity and hedge funds are

re-emerging out of the primordial financial slime, high-frequency trading and dark pools are bigger than ever, investment banks have been pushing hybrid securities as the new big thing and credit rating agencies, known as the "key enablers" of the financial meltdown, continue to assign credit ratings to all manner of products, albeit with more consideration.

The reason is simple. The collapse of Lehman Brothers and the crisis that ensued was caused by a confluence of factors, but at the heart of them all was regulatory failure. As Frank Ashe, associate professor of applied finance at Macquarie University, says: "Using existing regulation properly would have prevented the problem ... The new regulation is not going to do anything if it's not applied. So far we've seen things like [the Sarbanes-Oxley act] being ignored by the big banks and shadow banks, and the US regulator is apparently doing nothing. CEOs are supposed to sign off that they have a decent risk management system. Jamie Dimon [JPMorgan Chase boss] signed off a system that didn't notice the London Whale. The CEO of AIG [American International Group] signed off on systems that didn't notice their London office storing up more barrels of gunpowder than Guy Fawkes. Jon Corzine hasn't been brought up for MF Global, which collapsed [in 2011]. Sarbanes-Oxley has been in place for over 10 years. And they think Dodd-Frank will fix things?"

While there has been a lot of jawboning by regulators all over the world over the past few years, along with myriad investigations into what went wrong and threats of global regulatory crackdowns, little of any meaningful nature has been done.

The banks have been forced to hold more capital but they are still arguing about how much. And frankly, the question of whether they need to hold more liquidity is a question worth raising because during a crisis there will never be enough and in normal times extra liquidity isn't needed.

There is also the issue of the over-the-counter market, or

off-market, which is where much of the trouble happened initially. In Australia, the OTC has long been the stomping ground for derivatives, contracts for difference and other exotic and opaque financial instruments, as Australian charities, super funds and local councils found to their detriment. A central clearing system is being established but transparency will still be an issue because it is designed for generic products rather than more complex products.

Against a backdrop of the OTC market, auditors who don't do proper audits (a report by ASIC released late last year shows audit quality went backwards in the previous 18 months and that in 18 per cent of the key areas it reviewed, auditors did not obtain sufficient "appropriate audit evidence, exercise sufficient scepticism, or otherwise comply with auditing standards"), independent property valuers who aren't so independent because they get paid to give property valuations their clients want, the credit ratings agencies that assigned credit ratings to toxic instruments and got paid for it, financial planners who scammed investors, hedge funds who made money from short selling and rumourtrage and directors who flouted continuous disclosure rules, and the rise of dark pools and high-frequency trading, the need for strong regulation, not necessarily more regulation, has never been more vital.

There has been a lot written about what went wrong to cause the crisis but little has been written on the cost. A study just released by the Federal Reserve Bank of Dallas estimates the cost at between $US6 trillion and $US14 trillion in the US alone.

In Australia the damage was far more subtle due to the strength of regulator APRA, but still not insignificant. For instance, more than $150 billion of the country's retirement savings went up in smoke, forcing many to delay their retirement. A number of high-profile companies including Babcock & Brown, Allco and ABC Learning collapsed, and two broking houses, Tricom and Opes Prime, almost brought the ASX to its knees. Too few have been punished for the many financial crimes.