Leap Of Faith

The President, at Cooper Union, declared five elements crucial to financial services reform:

* Instituting a system to ensure that "American taxpayers are protected in the event that a large firm begins to fail."
* Imposing the so-called Volcker Rule... limits on the freewheeling trading and risks taken by banks.
* Setting new transparency rules for derivatives "and other complicated financial instruments."
* Assuring "strong consumer financial protections."
* Instituting "pay reforms" to give investors and pension holders "a stronger role in determining who manages the companies in which they’ve placed their savings."

The logic behind the proposed mechanisms are, to a certain way of thinking, very straightforward: To protect American taxpayers from the failure of these Leviathan firms, regulators need to be empowered, in the first instance, to reduce the likelihood of failure and, in the second, to manage an orderly unwinding. Reducing the likelyhood of failure argues for the Volcker rule, pay reform, as well as greater transparency rules, so that regulators have an easier time understanding market interdependency. Finally, and certainly, ordinary customers have to be protected from predatory practices.

Ultimately, this logic demands large leaps of faith: It is simply irrational to believe that large Leviathan firms, representing double digit percentages of GDP, can be orderly unwound without requiring heavy taxpayer subsidy. The belief that, left to broad politician-regulator discretion, they can be fairly unwound, defies recent experience.

The bill itself calls into question the belief that a new, more complicated, patchwork of super-empowered regulators will reduce risk. The Volcker rule, premised as it is on the nonsensical notion that holding a loan is entirely different and less risky then buying a bond, and the politically popular, but economically misguided, "Pay Reform", are embedded evidence that this reform, will serve not to limit, rather -- in the now tried and true form of creating distorting market inefficiencies / regulatory arbitrage opportunities -- create risk.

Finally, if Madoff passed SEC scrutiny, and repo 105 passed muster with Fed employees placed at Lehman, how can Mom and Pop investors rationally expect to be reasonably protected by yet-another-agency?