Engineering financial products to fail should be jail-worthy

The worst financial crisis since the Depression happened because financial risk got ahead of the world’s ability to manage it. The boundaries between government and markets are being redrawn, but, unfortunately, not in a way that would keep a similar crisis from happening again.

Modern finance has spread capital more widely and improved countless lives. The financial world, through saving, investment and insurance, exists in part to help provide financial security. Recently, though, because we lack appropriate regulation, the entire market became increasingly risky. As the meltdown has proven, when the financial system fails, everyone suffers.

What happened? One of the most notable and spectacular revelations is that the crisis was exacerbated by investors designing financial instruments to fail. That’s right, financiers grew rich even as they put their industry and the prosperity of the entire country in jeopardy. The managers at Magnatar and Goldman Sachs who devised these intentionally toxic collateralized-debt obligations profited by packaging them and then made millions, maybe billions betting that their products would fail.

Even worse, these managers created a huge market for toxic sub-prime mortgages. Which in turn caused thousands of families to be approved for mortgages they couldn’t afford – and, quickly thereafter, foreclosure. This made the mortgage crisis far more devastating than it should have been.

Are the families who took on more mortgage than they could afford blameless? Of course not. Yet, it’s doubtful that any of these families would have accepted the mortgage if they’d been told that their mortgage existed because it was expected to fail.

This isn’t how finance is supposed to work. This isn’t how “hedging” is supposed to work. What this is is an intentional manipulation to stress the market and then profit from that stress.

These managers should be jailed for life, in my opinion. But, unfortunately, what they did was not illegal. It needs to be.

We need a nimble agency that can keep up

Unfortunately, Republicans have filibustered financial regulatory reform – a waste of energy on their part because the Democrats haven’t put together a reform package strong enough to actually make a difference.

The Republicans are at fault for failing to see that sometimes regulation is actually necessary, but the Democrats have doubly failed by proposing legislation that threatens to spend taxpayer money on a new layer of bureaucracy without actually giving these folks the authority to do anything.

As former U.S. Treasury secretary Hank Paulson has said, we can’t have “politicians coming up with a set of rules that will become outmoded and outdated over time.”

Instead, we need a nimble agency that can keep up with the clever financiers who are always looking for new loopholes. The agency also needs to be simple and flexible enough to adapt to the shifting market, but, and this is key – without completely shackling the market. Indeed, most of what these clever financiers do is incredibly good and deserves some of the credit for the prosperity of the past 20 years.

It is difficult to tell whether Democrats are watering down regulation reform due to enormous financial contributions from the financial sector, an attempt to get some bi-partison support, or simple lack of vision.

However, it is a sorry fact that unless we get comprehensive financial regulatory reform, we will leave our financial sector extremely vulnerable. We simply cannot afford to do this.

Elisa Cundiff is the blogger behind NMPolitics.net’s Balder and Dash. She helped launch Thrive, a free personalized financial advice software program designed to provide financial tools to those who need them the most. She also presented Thrive to congressional staffers in D.C on financial literacy day on Capitol Hill, and has provided information sessions with Operation HOPE from the President’s Advisory Council on Financial Literacy. E-mail her at elisa@nmpolitics.net.