Financial products need an FDA-style regulator

By Eric Posner and Glen Weyl from Bloomberg

In February, Mary Schapiro, chairwoman of the Securities and Exchange Commission, said the agency is looking for ways to rein in high-frequency traders, who use computer algorithms to buy and sell derivatives at lightning speed to make instantaneous profits. High speed trading  can waste resources and disrupt markets, so the commission is right to look into it. But this is only one issue at the edge of a bigger problem requiring significant government intervention.

The larger challenge is that much of the U.S. financial system is devoted to wasteful activity – useless trading that advances no important economic interest but, at the same time, creates a dangerous risk of economic crisis. The way to control this wasteful speculation is to require government approval of all new financial products, subjecting them to the same sort of examination and regulation that the Food and Drug Administration applies to new medicines.

Before there was an FDA, quacks peddled useless, and sometimes dangerous, tonics like radium water. Yet for all the harm such concoctions caused, they may never have matched the risk and waste of some financial derivatives – what Warren Buffett has called “financial weapons of mass destruction.”

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