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The Right Approach to Regulation

Paul Singer, a member of the board of COMMENTARY Inc. and founder and chief executive officer of Elliott Management Corp., has an important piece today in the Wall Street Journal about the need for a new global regulatory system to prevent the taking of apocalyptic risk:

Creating a regulatory system that reflects the modern-day realities of financial markets is not as difficult as it may appear. The financial structures that destabilized our markets have definable characteristics….It is critical that any new regulatory initiative have a global mandate and contain mechanisms to prevent “risk infection” by countries that try to dodge risk controls. There are legitimate concerns about the time needed to devise a global risk-management system and staff it with individuals with the requisite sophistication and experience. But there are relatively simple solutions.

First, the government can hire private firms to assist in assessing risks posed by complicated financial instruments. Despite the failure of financial CEOs to understand the wizardry invented by their own “rocket scientists,” there are independent firms such as Duff & Phelps that can make sense of these products and serve as objective advisers.

Second, interim steps can be adopted to immediately rein in leverage and risk, such as increasing margin requirements for certain types of instruments. For example, in order to initiate credit default swaps, all parties (including dealers, who currently put up little or nothing) should be required to post deposits or reserves of at least 15%, if hedged against a credit instrument of the same company, and 30% otherwise…

I understand the inclination among free-market conservatives to dismiss the government’s regulatory efforts as misguided. Some government actions over the past year have been reactive and incomplete. Yet these actions have been large and reasonably fast, which were the critical elements for the survival of the system.

Read the whole thing.



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