Monday, June 29, 2009

You Can't Regulate Against Stupidity

The Bank for International Settlements has released some new guidelines for financial instruments, the 'new normal' according to Financial News. BIS says that complex structured products such as risky derivatives should only be marketed to suitable sophisticated investors. BIS likens these to pharmaceuticals, where the availability of prescription drugs is controlled. On the surface this sounds like a good idea but, like prescription drugs, you cannot control the demand from unauthorized parties. With drugs, teenagers and pushers will raid parent's medicine cabinets and steal from hospitals to satisfy their needs. With complex derivatives there will be a similar pattern. The banks will create the newest 'bubble' product and rake in the cash. A pension fund in Iowa will see how well investment banks are doing trading the 'hot' product and will want it for its clients' portfolios. Like a pusher, some middleman somewhere will ensure they can get it. The fund will load up with inappropriate instruments and will unlikely be able to manage the risk properly. Banks win, pensioners lose. The banks love complex financial instruments for this reason. And they need to get them out to the financial market equivalent of teenagers and users for this reason. It is difficult to make gazillions on OTC derivatives if you can only trade them with a handful of other players. And impossible to create another bubble.

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