Waterloo researcher looks at what makes markets tick…or tank

James Thompson saw trouble when he was working on his doctorate a few years before the credit collapse that started in 2008.

Photo credit:Patty Mah

He was studying risk in the financial world, specifically unregulated investment contracts known as credit default swaps (CDS). One party insures the debt instruments -- bonds and mortgages, for example -- of another and the second party pays premiums.

A popular product, CDS’s were often propped up on weak collateral and embedded in dense contracts that distanced buyers of CDS’s from the root debt.

“People couldn’t believe this was a real problem,” says Thompson, now an assistant professor at the University of Waterloo’s School of Accounting and Finance.

As the dust still settles from ruined investment firms and wrecked households, the credit collapse has become an area of intense academic study, especially around building stability. Thompson still studies CDS’s, arguing they should be better understood rather than entirely avoided.

Never in Canada, eh?

Meanwhile, Canadians needn’t feel too smug that their more conservative, more regulated financial system came through the credit collapse better than most. Americans have more banks to choose from; our banking is concentrated among several big players.

If one were to fold, the impact would be severe and widespread and we’d have less banking competition when it was over, Thompson says.

He also examines the character of the financial world: “Why people do what they do, and what information they have when they do it.”

By focusing only on the advantages that risk-taking delivers in the short-term, some business leaders create what he calls “financial pollution” for others downstream.

This is where checks are needed, Thompson says: “How do we get people in power to have a more long-term perspective in their decision-making.”