Michael Lewis in his recent interview told Mint and WSJ that the solution to a more more robust financial system lies in eliminating counter party risk. The way to eliminate counter party risk according to him is through introduction of an exchange in all dealings ensuring that default by one party is not cascaded through the system. This solution translates as death of OTC products. Here is the link to full interview:
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His arguments carry little logic. OTC will never go away simply because an exchange works only for common, relatively high volume, standardized instruments. Alas one size does not fit all and the number of custom designed contracts necessary to meet basic day to day financial needs is vast and they will remain OTC. More over exchange only eliminates counter party risk in a trade which isnt as a big a risk as it is made out to be. An exchange does not hedge the inherent risk of an instrument and that is the real financial risk. Also in case of contracts an exchange does not resolve systemic risk of settlement failure if a large FI were to go under. I have many such arguments which seem very good till you scratch the surface. None of them will resolve the basic problem of bad decisions and imprudent risk taking.
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