Will regulating everything really control risk?

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The Obama Administration wants to solve risk problems on Wall Street by regulating everything it can put its hands on. Its new programs include increasing the control that the Federal Reserve has over banks and other financial firms. A new consumer protection agency would be formed. Credit derivatives will be scrutinized.

Most of the details of the new plans have been leaked over the past several days. According toThe Wall Street Journal, "One new detail is that any large, interconnected company that the government wants to take over and break up could be pushed into government seizure by the Treasury Department."

Leaving aside the specifics of the plans, if that is possible, what the government hopes to do is put the risk genie back into the bottle. It served the needs of the markets well by providing capital to drive up the stock market and give corporations and consumers access to capital, perhaps too much capital. It helped bank earnings by creating exotic financial instruments to harness the power of the growing mortgage markets.

What the government does not want to admit is that there is always a new genie. Several decades ago it was Latin American debt. Shortly after, it was leverage of S&L assets. Most recently, the ability to trade risk through credit default swaps has become a tremendously large market.

The trouble is that regulating risk is usually based on looking back at the history of a financial crisis and not by looking forward at what financial firms may do to create new instruments to increase returns for themselves and their customers. And, that is as it should be. Predicting the future is impossible. Trying to regulate future risk would take all of the capital creation power out of the financial industry.

Regulation won't stop the next market mishap because no number of regulators can predict what that will be.

Douglas A. McIntyre is an editor at 24/7 Wall St.

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