Your best explanation yet. But I still disagree with your conclusion. The opinion of the "long volatility" trade was utterly obvious. Most of us saying there is a credit bubble now, were saying it in 2005. My personal posts here pointed out the absurd lending practices and subsequent asset bubble. I didn't get into the cause and effect then because I didn't know enough about it. Now I know that the demand for overrated traunches came from several factors, the main one being carry trade from low short term rates. It was trivial to borrow at 2 or 3 percent and buy longer duration securities with whatever yield was available at "AAA" (which were based on ludicrous assumptions). That is what drives down spreads, not the asset bubble, or lack of knowledge of the bubble or anything else to do with the asset bubble.
The implication that "volatility" or risk is somehow involved in all of this is about as ludicrous as the fake "AAA" ratings and fake insurance on the "AAA" ratings. The market has discovered that fraud and has now priced accordingly, but your plan will not prevent such malarky in the future.
Actually it will... you just don’t understand how those investment decisions are made. You don’t get what professional money managers actually do for a living. That’s OK of course, it’s no reflection on you that you don’t. You have some other job that I probably don’t know all that much about (certainly not as much as you), but it’s pretty clear that it’s a mistake to assume that you know enough to understand the consequences of what I’m talking about.
If the long vol trade was so obvious to you, then you’d be a billionaire right now, and you’re not. The fact that it would blow up eventually was obvious to everyone, but no one could forecast when it would blow up. My proposal would make that forecast possible for those who do this for a living. And that would prevent the market crisis by “creating” liquidity at the most crucial time. Assets will still fall and rise, market volatility will still be present, just like it was during the Amaranth collapse, but it won’t be a broader market crisis.
I’m sorry to put it so bluntly, but the fact that you don’t understand it doesn’t mean it won’t work... it only that you don’t understand it.