|William Cohan has a nice piece on the suggestion made by several people--most recently Gretchen Morgenson--to create an agency to "test" derivatives before they are allowed to be sold. He debunks the proposal, and gives the simple solution to the problem--make the executives accountable.|
FDA for Derivatives Won’t Defuse Wall Street’s Bombs
By William D. Cohan Apr 8, 2012 6:05 PM ET
Excerpt with the critical passages:
This is beyond ridiculous, for the simple reason that there is no way to deconstruct a financial product before it goes to market to determine whether it will end up doing more harm than good. Yes, the excesses in Milken’s junk-bond market helped cause the speculation in the stock market that led to the Crash of 1987. But both before the crash and most certainly for the last 25 years the junk-bond market has been robust and vital, allowing thousands of companies access to capital while also providing investors with the sorts of risk-adjusted yields they most certainly cannot find in the overinflated Treasury market.
Much the same can be said for the securitization market, which worked brilliantly for more than 20 years before credit standards deteriorated miserably in the middle part of the last decade, sending the mortgages tied to them and the entire housing market spiraling downward. Chances are good that as we emerge from the downturn, securitization of mortgages will again be a viable and important market.
The problem on Wall Street is not financial innovation per se or the risks tied to untested products. Rather, it is a terribly outmoded incentive system that rewards -- with big bonuses -- the Wall Street armies who generate revenue by selling the array of new products without any accountability.
The key to Wall Street reform is to make Wall Street executives, traders and bankers once again financially liable for what they are selling. If that were the case -- as it was when Wall Street was a series of private partnerships -- financial innovation would once again be revered and help to restore the luster of America’s capital markets.