So now financial regulation is the next big policy initiative on the part of the federal government. As this discussion goes on there has been much talk about the ability to stop bubbles before they get out of control. I guess the concept behind this goes to the idea that we regulate the general economy the same way, through monetary policy, when the economy overheats we tighten the money supply and so cool down the economy. This concept works well with the general economy, but bubbles are much more specific things, not everyone has a stake in a bubble.
So the problem here is that whoever this regulator is, be it the Fed, or whoever, will be placed in a position of deciding who are winners and losers. Now with the amount of big players in the investment community, pension funds, college endowments, trusts, insurance companies, 401ks, IRAs, etc., this could turn out to be a huge deal. This is because when the regulator moves to pop the bubble, that is exactly what they will do. If it is an equity bubble, then equities fall. So maybe some endowments new this was going to happen, but a bunch of IRA managers didn't, so the endowments win because they moved out before the popping, and the IRA managers don't, they lose money, because they weren't as smart, and the regulator is to blame for this.
A better approach would be to address the underlying causes of what allows bubbles to happen. Now there are a bunch of reasons for them, arcane financial instruments, speculators, the rate at which assets are permitted to be bought and sold, and what have you, but the really big reason is liquidity levels. You have to have enough cash out there to fuel the bubbles in the first place. That is what we should really be looking at, because right now the amount of liquidity out there can do nothing other than fuel bubbles. And please don't tell me that the cash needs to be there to fund business operations, the amount of liquidity floating around in the global economy is so far beyond that it can only be used for gambling.
Now at this moment there is a huge amount of speculation going on in financial instruments like CDOs, and while this gambling on pieces of paper with little connection to hard assets is wastefull, and ultimately harmfull we must admit that bits of wealth fall out of this system to fuel a degree of real economic activity. Yes the hedge fund manager does employ a gardener, which he would not if he were flipping burgers. The only problem is that the business of the hedge fund manager could drag down the entire economy if it crashes. So while it would be nice to not have the "real" economy held hostage by the whims of speculation for speculations sake, to get rid of this means to pull a lot of economic activity out of the economy. Would you do that? It is like being willing to take a wheelbarrow full of banknotes and set it on fire. If it set you free, would you do it?
I would because I am not in to greed for greeds sake being a driver of the global economy.