4th April 2012
The potential dangers of financial instruments, argue two professors at the University of Chicago, "seem at least as extreme as the dangers of medicines." So they should be vetted by a "financial products agency," like the Food and Drug Administration for drugs.
Full disclosure of risk is not enough, they claim, as information seldom deters people from acting against their best interests. A drug that does not work or has harmful side effects should be kept off the market to ensure that people won't buy it. That is an interesting point, as the inference is that if investors were to be informed that a financial instrument is potentially dangerous or toxic they would not be deterred from buying it. They will gamble with their money, as they should not be allowed to gamble with their health.
They have an interesting point, essentially based on a clear discrimination of the markets for goods and services, which by and large should not be regulated, from financial markets, which can be socially harmful. As Gretchen Morgenson, the reporter for The New York Times, put it in her account of their proposal: "For example, financial instruments could be judged by whether they help people hedge risks – which is generally beneficial – or whether they simply allow gambling, which can be costly."
The poster child for dangerous instruments that incite financial speculation is, of course, the "credit default swaps" that played such a critical role in the credit meltdown of 2008. Imagining a credit default swap being brought before a financial protection agency, the professors wrote: "We would expect the F.P.A. to treat it skeptically."
The professors say their goal, though, is not to protect investors from shady practices but to "deter financial speculation . . . [that] contributes to systemic risk." (See, "How to Prevent a Financial Overdose.") Only if the economy is endangered by excessive risk should government step in.
I doubt if investors, small investors particularly, want to gamble. It's one thing to buy a lottery ticket or go to the races, but most of us want to protect what we have stashed away for our children or for retirement. We are retail shoppers, looking for bargains, perhaps, but not looking for windfalls. Credit default swaps were never targeted for the man on the street.
So what are these professors really saying? My guess is that they are dancing on a tightrope, wanting to affirm the primacy of free markets, like all their peers. Investors ahold be allowed to gamble and, even, run the risk of being hoodwinked. But lacking confidence in the ability of the financial industry to use its own good judgment, they want to regulate them. It's not the consumer who needs protection. It's the big investors that need to be reined in.
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