Doing Something About Derivatives

Largely blamed for the financial disaster, though there were many other systemic problems, derivatives are a major component of President Obama’s newly proposed overhaul of our financial system, according to today’s lead story in The New York Times.

The regulations announced by the Treasury Secretary, Timothy Geithner, would require the trading of derivatives on public exchanges and their backing by capital reserves, just like a bank must maintain a certain amount of capital reserves in case a borrower defaults on a loan.

Apparently, the main culprit in the current derivative situation, according to the article, is the Commodity Futures Modernization Act passed in December 2000. That act deregulated derivatives and was supported across the political spectrum. At that time, the derivatives market was small, but it subsequently grew to $680 trillion.

Some of these economic matters seem very arcane and complex, but the broad outlines are simple. Financially sophisiticated players take advantage of the rules to get advantages over the rest of us. No matter how many times the U.S. government tries to reform the markets, this phenomenon will always occur. It is a basic element of human nature and greed. Still, the effort to reign in abuses must proceed, and it is good to see the Obama administration leading the way.