R E - R E G U L AT I N G U . S .

F I N A N C I A L M A R K E T S T O R E D U C E S Y S T E M I C R I S K

The primary purpose, the mission, of financial institutions is to “direct a nation's savings into the
most productive capital investments – those that enhance living standards” for a sustainable fu-
ture;1

MARKETS MUST PRICE SYSTEMIC RISK IN TRANSACTIONS

Financial markets have two primary tasks:

to efficiently reallocate capital and labor to projects that provide the technological
innovation the economy requires for growth, and

to protect and maintain liquidity so that growth can continue over the long run.

When markets successfully accomplish these two primary tasks, they are adequately
managing risk: maturity, liquidity, market, credit, currency, technological obsoles-
cence, and wider economic, ecologic, and political risks. Today’s economic collapse is
the result of a massive failure of financial markets to effectively manage risk.2 To ef-
fectively manage risk going forward requires, rescue, restructuring and re-regulating
financial markets.

Market risk consists of the danger of mispricing assets; credit risk covers the po-
tential of financial promises not being honored; currency risk describes a mis-
match between the value of liabilities’ and assets’ respective currencies; techno-
logical obsolescence describes the technological progress in achieving more out-
put with less input of labor, capital, and time; larger economic, ecologic, and po-
litical risks refer to black swans, those highly improbable events such as global
crisis, war, political upheaval, and ecological collapses that impact markets.

These risks are global, interrelated, emergent (the outcome cannot be fully predicted
by antecedent causes) and need to be addressed in a timely fashion.

Markets require structure (rules of the game) to function efficiently. Regulations help
to define this structure as fair and equitable for all parties who wish to transact busi-
ness in this market.

The quality and timeliness of governmental regulations may be the single most im-
portant forcing function for financial markets to accurately assess risk and respond to
new risks that emerge. Governmental regulations form the foundation on which the
financial markets’ pyramid of promises rest. Regulations and enforcement must be
capable of rapidly adapting and evolving for changing market conditions.

1 Alan Greenspan, “We need a better cushion against risk,” Financial Times (26 Mar 2009).

2 Requiring taxpayer-funded debt, guarantees, and tax relief of $2,960 billion in 2008, poten-
tially another $2,700 billion in 2009 and producing $6,900 billion losses on Wall Street during
2008 and additional multi-billion dollar loses on Wall Street so far in 2009.

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R E - R E G U L AT I N G U . S . F I N A N C I A L M A R K E T S TO R E D U C E S Y S T E M I C R I S K

MANAGING RISK REQUIRES ACCURATE PRICING INFORMATION

Unregulated markets tend to develop unfair pricing practices that are driven by ava-
rice. This leads to the inefficient allocation of capital by financial markets that are not
adequately regulated as risk is not effectively managed. Over time, if capital is not
efficiently allocated to activities that are productive and that produce a real economic
return on invested capital, the economy tends towards collapse. Thus, the primary
purpose of regulations is to prevent this collapse due to the inefficient allocation of
capital within the economy.

Present fundamental and structural inadequacies in government regulations enable

domestic (and global) markets to misprice inputs and outputs of the economy by:

deferring known economic costs to the future; or

failing to account for known economic costs and pushing these costs to public
taxpayers.

These inefficiencies result in an unstable economic system that is prone to massive

corrections. This results in an economy that lurches from crisis to crisis with ever-
spiraling costs to taxpayers and that shatters the lives of its victims. Unstable econo-
mies may not only be a source for waves of financial crises, but also a source for local
resource wars and terrorism as preferred methods for sorting out temporary winners
and losers. This often leaves American taxpayers exposed as the lender and borrower
of last resort.

RESTORING TRUST IN FINANCIAL MARKETS GOING FORWARD

Restoring trust in financial markets going forward requires timely policies and ac-
tions on the part of government and the financial institutions. Present fundamental
and structural inadequacies in government regulations enable uneconomic decisions
and gaming of the system to dominate. Instead of promoting innovations and reallo-
cation of capital to the most productive uses in the economy, capital is employed for
self enrichment and in ways that destroy the wealth of the nation (both financial
capital and natural capital).

Regulations are often thought of as point solutions to immediate problems. Financial

market issues are often in response to larger economic issues that evolve and become
more urgent or important as understandings change. Government needs institutional
mechanisms that are capable of altering, suspending or replacing existing regulations
at short notice in response to large-scale, changing market conditions. Without this
capability, the risk is the possibility of market collapse.

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