Pause and consider for a moment the fact that no amount of regulation of financial markets can squeeze the effects of stupidity out of the system.

The Administration plans a radical overhaul of how banks and financial trading are regulated. The Fed will control most of the turf of watching banks. The Treasury will be able to participate in dismantling large firms that have to be dismantled.

One of the keystones of the new programs is an agency to help consumers from being preyed on by Wall St.  Banks and brokers will be prevented from taking advantage of the average citizen who wants a mortgage or a credit card. This part of the structure of the new regulation has an aspect of protecting consumers from themselves. A bank may offer a customer a $500,000 mortgage on a $400,000 home. The government means to prevent that.

While a good deal of what happened in the mortgage and consumer credit markets resulted from institutions giving people the ability to take on financial leverage that was beyond their means, it was based on the desire of millions of Americans to borrow money instead of save it. A person with a $50,000 pretax salary who cannot figure out that he cannot afford $20,000 in credit car debt which carries an 18% interest rate is either a rank optimist or extraordinarily naive.

The new laws that the Administration and Congress mean to put in place spring from the concerns that investment banks and commercial banks created leverage that they system was unable to sustain. A large insurance company could buy a mortgage-backed security and perhaps double its money on the investment in 18 months. No actuary at the company asked whether that was possible or whether the instrument carried extraordinary risk. S&P and Moody’s (MCO) dispensed their blessings of the paper, so it must have been as safe as the bullion in Fort Knox. In reality, it was just as risky as trading credit default swaps on certain tranches of Lehman Bros. debt.

The new laws that will allow the government to look into the heart of financial companies balance sheets and bank management decisions about investment and risk will keep both companies and individuals from betting too many assets in the most dangerous parts of the market. No amount of risk can keep a floor trader from trying to triple his firm’s money in a single trading day.

Douglas A. McIntyre

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