Why Derivatives Are Taking a Drubbing

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You might have expected Congress to muddy financial regulation with carve outs and compromises that water down the Senate bill. But it hasn't worked that way for derivatives. Sen. Blanche Lincoln proposed a super-tough plan that would force financial institutions to split in two if they want to keep trading these complex instruments that help financial institutions hedge other bets, and it hasn't attracted much negative attention on Capitol Hill -- even though some politicians do whisper quietly that it might be a little too strong.

Noam Scheiber explains that the White House recently recognized that derivatives were the perfect public relations weapon to wield in the run-up to financial reform. "Rahm's view is: 'I like the derivatives issue,'" one administration official told Scheiber. "We're on better ground on that than talking about bailouts. If they talk bailouts, we talk derivatives."

How did derivatives help make financial regulation stronger? Maybe it helps that nobody knows what the heck they are. Kevin Drum has a smart take:

If you propose an agency that's going to regulate consumer credit, it's entirely possible to get the citizenry riled up about it. You make some arguments about how it will make it harder to get a home loan or qualify for a credit card or something like that. People get that...

But derivatives? It's the fact that they're arcane that makes them such a great target ... From a pure PR perspective, the very fact that derivatives are (a) arcane and (b) solely the preserve of gigantic Wall Street firms make them a perfect target.

Financial regulation is extremely complicated. Remember, we're in this mess partly because Wall Street didn't fully understand the risks of its shadow banking system. It's easier to message the public about leverage (The banks are too big!) or the resolution fund (Bailout fund!) than derivatives (Hey folks, credit default swaps are just like your home insurnace, except! Instead of you taking out insurance on your own home, it's our swap desk taking out insurance on a security backed by the mortgage on your home.) And it's easier to build a campaign against something you can package in a few words.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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