Regulate Investment Banks?

Hell yes!Bladerunner

After four years consulting for a financial services company, I say regulation can’t come fast enough to investment banks, hedge funds, and private equity funds. They weren’t doing anything technically illegal, but they certainly were being too clever, too greedy, and too secretive. Now we’ve got some nose-on-your-face evidence with the mortgage meltdown and collapse of Bear Stearns that they need oversight. I invoke the Blade Runner Test:

Rachael: It seems you feel our work is not a benefit to the public.
Deckard: Replicants are like any other machine: they’re either a benefit or a hazard. If they’re a benefit, it’s not my problem.

The same is true of the byzantine instruments and predatory fee structures running rampant through the alternative investments space. The hazard comes in two forms:

(1) Institutional investors like pension funds are exposing their members to unacceptable risk. These individuals can’t invest directly in things like hedge funds because they aren’t qualified investors, a fancy way of saying “rich enough to lose a million dollars and not feel it”, but now they’re exposed indirectly with their very futures at stake.

(2) The financial system is a house of cards with players so heavily indebted to each other that one falling could topple the whole system. I don’t like what the Fed did, but they were dead-on about preventing a complete seizing-up of the financial industry–a substantial, growing part of our GNP as we forget how to produce real goods, services, and new ideas. The country as a whole would bear the brunt of the suffering–either via bailouts or a 21st century worldwide depression that might make the 20th century one seem mild.

What boggles my mind is how predictable this all was. The reasons why things are falling apart now are the same reasons we regulated banks and securities after the Great Depression. Besides regulating the existing instruments, I hope governments learn that they must regulate all new instruments at some minimal level to make sure Wall Street isn’t being too clever or cavalier. They also need to ratchet up the regulation whenever individuals are unaware they’re being exposed to risk via institutional investors like pension funds.

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