Derivative Regs: Failure is the Only Option

As of last week, our Regulators were continuing their interest in Derivatives, which according to them is that-which-caused-the-greatest-Recession-since-the-Great-Depression.

Here is a nice simple history of concern for greater regulation of Derivatives by our Best and Brightest:

"Administration officials want to establish a central clearinghouse for OTC derivatives, bulk up their regulatory oversight and require reporting for all derivative trades. They also want to determine which products can be considered standardized, and thus traded through the clearinghouse. Geithner and regulators from the Securities and Exchange Commission and the Commodity Futures Trading Commission outlined their ideas for OTC derivatives in May. A month later, the administration detailed these plans more fully when it rolled out its proposal for overall financial regulatory reform ... Nonetheless, lawmakers will seek details on the many vague components of the plan on Friday."

Not clear yet? Let me unpack it for you. The "greatest economic collapse since the Great Depression" was noticed by the Best and Brightest last Fall almost a year after it started. Playing catch-up, the Best and Brightest then began working furiously on the problem and finally settled on Derivatives as the culprit. After months and months of work, however, they were only able to float an "outline" of the problem. Thereafter, in June, they finally produced what they called a "detailed plan," which turned out a mere month later to be only the "vague components of the plan."

Here is the real problem: our Regulatory Guardians don't have any idea what Derivatives are, or were, or might be in the future, and so they really don't know exactly what kind of regulation is appropriate. In such a situation as this, the correct approach would be to regulate what you understand and leave the rest for the market. A simple bench-mark might be: identify those financial companies that are Too Big to Fail and prohibit them from indulging in such things. Then let anyone else who wants to play with Derivatives or Hedge Funds or any number of other financial buzz words that most of us normal citizens do not understand play their games with their own capital, and win or lose as the case may be. If a Big financial firm wants to play with such exotic financial products, then they can simply quit taking deposits of normal citizens, quit advertising themselves as Banks insured by the FDIC (aka you, the taxpayer), and simply opt out of the regulatory world, to sink or swim as the case may be.

This is, of course, almost exactly how our former regulatory system functioned before the Big Collapse. Investment Banks (do you remember them?) were financial players that never opted into the banking system of the United States and were therefore free to play any financial game dreamed up by the Best and Brightest wonks they could hire. Along about 2007, however, the merciless market, which had been so good to them for so long, turned on them with the ferocity of an ex-wife and they saw their precious capital disappear almost overnight. Following the logic of the market, which says that there will be winners AND losers, our government Best and Brightest let Lehman Bros. fail. But then they lost their nerve in an election season, and from then on it was Bail-Out City for any and every financial firm that had the foresight to hedge their portfolio with massive contributions to powerful Washington politicians (e.g. Senator Schumer, in this story from last December).

Government by the Best and Brightest of Government is an idiocy that has been inflicted on this Republic periodically since the Great Depression. It never works and in fact always leads to greater harm. Hopefully the public will wake up sooner than they usually do and thunderously rebuke these arrogant people at the next most convenient election.