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The most telling comment in last night's BBC Panorama programme on the banking crisis came from Chancellor Alistair Darling. First we had the pre-released stuff - in which Bank of England Deputy Governor Sir John Gieve pointed out that interest rates are too blunt an instrument, and that in future the Bank needs to be given more refined tools to target what he called "crazy borrowing".
He was also surely right to say that if the Bank had raised interest rates to deal with the problem of massive mortgages and soaring house prices, it would have been accused of sacrificing the wealth of the many to deal with the excesses of the few. Squeezing the whole economy would have been politically unacceptable.
Then we had Hector Sants, head of the Financial Services Authority, saying the banking implosion was a mix of many factors, from the behaviour of banks to changes in society's attitude to debt. It was unrealistic to expect the FSA to be on top of all of those factors. That, too, seemed eminently reasonable.
Finally, we had Barclays chief executive John Varley saying the banking industry as a whole should apologise for what has happened, but that bankers are not solely to blame. Government acquiesced in what was going on, he said. Indeed it did. Everyone likes a party, particularly one celebrating the end of boom and bust.
But Darling got to the heart of the matter. He was asked what had caused the crisis in the first place. The primary cause lay in the boardrooms of the banks, he declared.
He is not alone in thinking this. One of the topics that comes up most often at City lunches attended by people who were members of those bank boards is a clear understanding that the system failed, and that they as non-executive directors failed. Unfortunately, what no one has come up with are any changes that would make the system work better and ensure that it is less likely to fail in a similar way next time.
But that is where the real challenge lies, not in giving regulators more power. Lasting reform has to come from within.
Madoff fallout spreads far
One of the things investors have to get used to in times of deleveraging is the way in which different parts of the market that had hitherto appeared to be totally unconnected turn out not to be independent of each other after all. As a result, when one part of the business goes off the rails, its impact can be felt in all sorts of unlikely ways.
Take the Bernard Madoff scandal. The fact that he could pull the wool over the eyes of so many experts running funds of hedge funds has destroyed the credibility of that branch of the industry, innocent and guilty alike. The core competence of these managers is their claim to know the hedge fund managers better than they know themselves, so they can pick the winners and avoid the losers on behalf of their clients.
Failing to spot Madoff proves the hollowness of that claim for those caught by him. But the problem for the others comes when their shell-shocked clients believe it was luck not skill that meant they avoided a similar fate, and decide to pull their money out before their luck changes.
A second surprising thing to emerge is that some of these funds of hedge funds were themselves geared up, presumably to inflate their performance - but at the cost of considerably higher risk. RBS, for example, in announcing the possibility that it might be hit by the fraud, said it had lent £400 million against collateral to funds that had in turn invested with Madoff.
So some at least of these fund of hedge fund managers were borrowing to invest in hedge funds that in turn were highly borrowed. It means the worst offenders will be wiped out on the way down.
Even if that fear does not prompt clients to ask for their money back from the Madoff-free managers, other things might. Those invested in Madoff are bound to face a wave of redemptions, which means they will be forced to pull money back, and it is most likely that they will go to the better rather than the worst of their hedge fund investments because they have a better chance of getting their money promptly from them. That will depress returns of the good funds across the sector, dragging down the performance even of those well-invested funds of funds that avoided Madoff.
One final point: some managers hedged their positions against the indices of hedge fund performance in the same way that conventional fund managers lock in profits or guard against a market fall by hedging the FTSE 100 index. Unfortunately, the widely followed Credit Suisse/Tremont hedge fund index had Madoff funds in its composition.
Last week, it was forced to restate the returns of market-neutral funds for the year to date to compensate for the Madoff effect. It went from a 0.85% positive return for the year to date to a 40% loss. One shudders to think what effect an overnight change like that will have on any hedge-linked or stop-loss strategy tracking the index.
