Give me derivatives or give me death!

(www.aig.com)
(www.aig.com)

BY JOE FREEMAN — MEDILL NEWS SERVICE

Rene M. Stulz, professor of finance at The Ohio State University’s Fischer College, wrote an op-ed in the Wall Street Journal today entitled: “In Defense of Derivatives and How to Regulate Them.”

Peculiarly, the article had little to do with how to regulate them and almost everything to do with the defense of derivatives.

Stulz’s main argument can be summed up in one word: liquidity. Namely, that capital constantly flowing through the system is an undeniable asset to the economy and provides businesses and investors ways and means of hedging risk. Agreed.

But what if this system is abused, as it clearly was? What if liquidity turns into leveraging and weirdly packaged products and this all happens to coincide with a bursting bubble in, shall we say, housing?

Not to fear, says Stulz, all we need is a “systemic risk regulator” that will place participants under “federal regulatory oversight.” It’s strange to read a proposal for federal regulatory oversight of derivatives and not see any mention of the Commodity Futures Trading Commission, the federal regulator of exchange-traded derivatives.

Speaking of regulation, let’s not overextend ourselves, Stulz continues, claiming that we should leave “participants in capital markets free to engage in bilateral contracts for derivatives that fulfill specific needs as well as for new products.” Specific needs? New products? You mean like investors hedging their risk in mortgage-backed securities with credit-default swaps? Oh dear.

Stulz continues by allaying our obviously mounting concerns. “Derivatives are not the culprit,” he asserts near the end of the piece. Sure, liquidity is key, we need strong regulation, and there are many culprits (overreaching homeowners, predatory lenders).

But to free up blame and propose regulations that either already exist or won’t get the job done is futile at best and hurtful at worst. To say credit default swaps aren’t at all responsible for the meltdown, that they are “not the culprit,” is like positing that guns don’t kill people, bullets do.

The opinions expressed are those of the author and do not necessarily represent the views of medillmoneymavens.com, the Medill School of Journalism or Northwestern University.

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