Political Skullduggery

It was a bit of bad luck that yesterday was the day Robert Steel, the undersecretary of the Treasury for domestic finance, chose to lay out the Bush administration's case that the best protection against a market meltdown -- "systemic risk," as it is politely called in policy circles -- is not more regulation, but allowing markets to discipline themselves.

"Sophisticated financial firms have both the direct financial incentives and expertise to provide for effective market discipline," Steel told regulators and financial industry executives gathered in the Treasury's majestic Cash Room. "We believe that the collective decisions of self-interested and informed counterparties, reviewed by regulators, provide the very best protection against financial risk." Steel's goal was to head off calls for direct regulation of the hedge and private-equity funds that have come to dominate financial markets.

Steel's model is a fetching one. Banks deciding on their own to upgrade their "risk-management systems" to make sure that they do not have too much exposure to any one borrower or asset class or trading strategy. Pension funds and other institutions stepping up their due diligence before making investments, and insisting that hedge and private-equity funds provide them with background checks on fund managers and more timely information about strategies and performance. Funds themselves changing their cowboy trading cultures to embrace rules and procedures and reporting requirements that will prevent anyone from taking on undue or unauthorized risks.

It's a lovely theory, but it doesn't square very well with recent history -- the junk bond craze of the late '80s, the commercial real estate bubble of the early '90s, the Asian financial boom and the tech and telecom bubbles of the late '90s. For it is at times like these, when markets are at their most frothy and in need of discipline, that lenders and investors and the highflying fund managers tend to get the sloppiest.