Glass-Steagall and other Depression-era legislation was repealed based upon the claim that the modern financial system was totally stable.
The basis of this argument?
The financial boys thought they were so smart that they had modeled all potential risks for every investment or transaction using derivatives. And they convinced government regulators with their big talk.
Former Fed chairman Paul Volker explained that the entire modern financial system is based upon derivatives, and the financial system today is entirely different from the traditional American or global financial system because derivatives – a relatively new concept – now underly the entire fabric of the financial system.
How Are the New Tools Working for You?
Bernanke and Paulson and Congress constantly talk about all of the “tools” we have that weren’t available to stop the Great Depression.
How are those new tools working for you, boys?
Not very well, as the worsening financial crisis shows.
Why aren’t they working?
Economist, highly-regarded investment advisor, and one of the world’s foremost authorities on derivatives Nassim Nicholas Taleb explains (together with the creator of fractal theory and chaos theory, Dr. Mandelbrot) that the financial crisis will be worse than the Great Depression because of derivatives. Specifically, in a PBS interview, Taleb explains that the architecture of the current financial system prevents frequent periods of instability, but that when instability does occur, it is on a catastrophic scale.
Taleb is saying that – in thinking they were so smart by trying to control risk through the all-pervasive use of derivatives – the financial gambers have created a perfect storm which will result in a crash worse than the Great Depression.
All of the fancy “tools” in the world cannot solve the crisis unless derivatives are tamed, because – as Volker says – the entire financial system is built like a house of cards on top of derivatives. Or, as many writers describe it, the world economy is getting sucked into a black hole of derivatives debt.
As a writer for one of the leading British newspapers said a couple of months ago, trying to calm the financial storm without dealing with the huge derivatives liability was building a canvass tent as one’s strategy to weather a hurricane.
They are right, unless derivatives are tamed.