What is it about derivatives that makes otherwise rational humans become so damned stupid? There is no need to over-complicate this; a rather simple series of steps can be undertaken to bring the most dangerous of derivatives out of the shadows and into light of day.

The National Association for Business Economics does a semi-annual Economic Policy Survey of its members, who are primarily private-sector economists. The March 2010 survey isn’t up on their site yet, but this is what it has to say about the Consumer Financial Protection Agency:

“A key point of discussion in Congressional deliberations on financial services regulatory reform has been the establishment of an independent agency focused on consumer financial protection. Fifty-four percent of survey respondents feel that creating such an agency would not impair safety and soundness regulation; 25 percent believed it would be detrimental.  On a related issue, 43 percent of respondents indicate that a consumer financial protection agency would not impair access to credit while 39 percent believed it would.”

For nearly two years now we have waited for a speech.  We need a simple speech and a direct speech – most of all a political speech – about what exactly happened to our financial system, and therefore to our economy, and what we must do to make sure it can never happen again.

A question of values …

Derivative contracts are valued on a mark-to-market ("MtM") basis. This requires valuation of the contracts based on the current market price.

OTC derivatives trade privately. Market prices for specific transactions are not directly available. This means current valuations rely on pricing models.

In current accounting argot, most derivatives are Level 2 assets (Mark-to-Model). In practice, this means that they cannot be priced based on quoted trade prices (Level 1) but are valued using observable inputs; for example, comparable assets or instruments or using interest rates, volatility, correlation, credit spreads etc that can be put through an accepted model to establish values.

This represents my personal opinion, not the views of the SEC or its staff.

I am not going to spend time here talking about how the price of gold is off-the-wall, that it is not just a bubble in the making, but a bubble waiting to burst. I don’t want to waste your time on that point.We all know it is a bubble.

Self-deception is a remarkably useful form of mental disturbance. Calculated liars have to keep their stories straight, while the deluded are sincere and often unshakable in their misguided beliefs.

The Powers That Be insist that a magic bullet called a special resolution authority will solve many of the problems with the “heads I win, tails you lose” taxpayer backstopped financial system with inadequate oversight. The prospect of taking terminally sick banks out and shooting them will supposedly reintroduce moral hazard and make banks behave responsibly again.

What do current financial indicators tell us about where the economy is headed?

On 30 July 1998, Alan Greenspan, then Chairman of the Federal Reserve argued that: "Regulation of derivatives transactions that are privately negotiated by professionals is unnecessary." In October 2008, the now former Chairman grudgingly acknowledged that he was "partially" wrong to oppose regulation of credit default swaps ("CDS"). "Credit default swaps, I think, have serious problems associated with them," he admitted to a Congressional hearing. His current views on wider derivative regulation remain unknown.

Gretchen Morgenson has a fair number of critics among readers of this blog, which I think is a tad unfortunate. Most of her articles are in fact sound; she is very reliable on executive comp, anything in the equity markets, or where she is working form legal documents, generally lawsuits. It’s when she wanders into debt markets that her attempts to present material to a mass audience sometimes include nails on chalkboard slips.