Synthetics

One emerging consensus is that congress ban "synthetic" derivatives. As Senator Levin explains it:

As far as I'm concerned, we ought to eliminate the damn synthetics. To me, they don't serve any real purpose at all. They're just betting on something where they don't have a stake, they're not hedging legitimate risk. With other things, there's a limit. There's a finite amount of corn and wheat and mortgages. But these synthetics have no finite limit. So you literally have a gambling hall and the bets are unlimited. I'd get rid of them, and there will be an effort to get rid of them, and I will vote for it

While appealing, this argument is not true in full. Synthetic derivatives served some real purpose as real firms created demand for them. Even if they only served to encourage speculators, in doing so, they may well have served to decrease costs of hedgers of "legitimate risk". On the other hand, its easy to imagine that at some degree of abstraction, the synthetic derivatives do more harm than good and it, therefore, makes sense to have rules which, at least loosely, tie derivative trading to productive economic activity.

It must be said in all this that the idea that if the government doesn't understand the economic value of some activity, that value does not exist, is characteristic of command-, not free-, economies. In more free economies, private economic activity is not proscribed on the basis of perceived social value, rather it is regulated to the degree it threatens others. Trading in synthetic derivatives was only made threatening by the risk it posed to too big to fail/too big to manage firms. If Congress is, in fact, doing away with too big to fail, our traditional economic conceptions would argue for leaving synthetics alone.