Mark Lange

The most pressing business for the presidential transition team? Forget the customary interlude measuring the White House for drapes. Make it flights to Washington to meet with Treasury and Federal Reserve leadership, to begin restoring confidence in the financial system.

This can’t wait. It begins with the recognition that, behind all of the explanations and recriminations, what ultimately brought down the financial house were volatile investments known as “derivatives” — idiosyncratic and inscrutable securities “derived” from other securities, such as bundles of home mortgages. If we fail to regulate them, we will continue to invite the financial equivalent of arson.

The value of these financial abstractions has grown fivefold since 2002, to at least $531 trillion

today. That’s nearly 10 times the total output of all of the goods and services the entire world produced last year. At best, derivatives can insulate against investment risk. But because they’re entirely unregulated and trade on no public exchanges, their originators can deliberately hide their vulnerabilities. So anyone buying them risks burning down the house.

The most explosive derivatives? Credit default swaps — contracts sold to banks eager to insure themselves against default on the bad debt they knew they were issuing. These fake insurance policies sever the link between bank risk and borrower responsibility. Investment bankers lined up to bet on mortgage bankers’ not being paid back — wagering teetering piles of borrowed money on capital bases only 1/20th to 1/30th the size of the bets they’d placed.

And there is still $62 trillion in these bets on the balance sheets of banks and insurers. Wall Street’s high finance has amounted to magical, money-for-nothing thinking. We got into this mess through a deliberate obstruction of regulation — a dogmatic dereliction of duty on the part of the Fed.

The only way to keep Wall Street from doing further damage is to demand regulation of the derivatives still circulating in the financial system — particularly the $62 trillion in the market for credit default swaps. Whatever remains of investment banking should never again be allowed to borrow and bet $25 for every dollar that’s theirs. Hedge funds need basic oversight. Then, after putting derivatives on a regulated exchange, it will be time to rework our present Rubik’s Cube of financial authorities into a more coherent framework.

While rumours of the end of capitalism as we know it are greatly exaggerated, the need to install a few regulatory smoke alarms is now excruciatingly obvious. For the rest of us, if nothing else comes of this disaster, may it force us to refocus on savings over consumption. Not bigger valuations — better values. Wh-at made this country were simple ideals — hard work, patience, thrift, and integrity — not the sophistry of financial abstractions that fire up Wall Street and burn Main Street. The sooner we get back to real business, the better.