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Saturday, May 15, 2010

Financial Regulation - A Common Sense Solution

There are days when complicated issues come on display in a different light, and, suddenly, they look much simpler. It recently occurred to me that the problem with the financial industry may not be residing in the behavior of its players, nor in the ways it functions; it has more to do with the commercial attributes of its products.

I was always troubled by the terminology used in the financial industry. And, I am sure, I am not alone. When I hear bankers using a term like “product” my skin wrinkles, because I know that they do it just to disguise the real nature of the item that is being sold, and the risk associated with it. The psychological effect of calling derivatives and other financial instruments “products”, is that the public is more inclined to accept their legitimacy in the commercial space, as opposed to treat them as pure gambling.

In the real world the product is something that is conceived and made for public consumption or utilization. One of the most common attributes of the commercialized products is the warranty that comes with the transfer of title. That is the real guarantor of quality and performance, even more so than the brand name and firm reputation. In some instances it even comes with an extended warranty, as a differentiator. In the name of this warranty, the product is usually returnable for and exchange, or for a refund if it does not perform to the satisfaction of the buyer. The only other sector where the buyer bears the entire risk of poor quality is entertainment: a ticket to a movie, or a baseball game, where the performance does not rise to the level of expectations is not usually refundable. But, at least in those cases, there is no presumption of potential for any material gain.

So why should the financial products be warranty exempted? Since the claim is that their creation and commercialization is the result of a similar process - concept, design, financial engineering, packaging, marketing, selling – why would they not be subjected to all other requirements of the commercial stream, including taxes? (How would you feel being charged 13% HST for the purchase of a stock, a bond, or any derivative?). To make it more appealing one can even buy insurance on such products. However, you cannot get any certificates of warranty. Isn’t that fishy? It certainly smells like it.

The way it is right now, there is zero accountability of the seller (or the commercial agent) to the buyer of a financial product. This lack of responsibility for the performance of the product is what encourages the speculators to misrepresent the risk of the investment, and hence mislead the buyer. In a world of total accountability, the financial institutions should be required to guaranty a minimum level of performance for their products. That is the only regulation that needs to be implemented: “A money back guarantee”. The rest would fall naturally into place.

Let the financial institutions be as big as they want, so long as they play by the same rules as everyone else. As true products, the faulty CDOs issued by AIG or Goldman Sachs should have been recalled, and the buyers (instead of being victimized) reimbursed the full purchasing values. It is easy to accumulate profits where everything is sold without consequences to the issuer. It is like shopping at the Flea Market, or buying from a Garage Sale. At least in those cases you see what you buy. In the virtual world of financial speculation there is no such thing.

So public beware when buying “products” through such an unregulated channel! As Michael Lewis once said in his book “The Liar’s Poker”: in the market there is always a fool; and if you don’t know who the fool is, it is likely that you are the one.

It is a shame that the financial sector attracts so many intelligent people (intelligence does not necessarily equal integrity) and wastes their talent as flea market merchants.

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