Incestuous Finance

I wonder how far it is possible to limit systemic risks insofar as financial entities continue to be black boxes vis-a-vis other financial entities and continue to be closely intertwined with each other. Reducing systemic risk might necessarily entail a regulated reduction of such intertwinings. Financial businesses are not like other businesses; it is too difficult to determine whether they are truly solvent and, via leverage, they can create disproportionate losses for those financial entities who do business with them. It is not part of their core contribution to the economy that they should so promiscuously trade with and invest in each other. They are required to efficiently distribute investment throughout the economy in non-financial businesses. This is their purpose. So long as regulation does not interfere with their ability to do this in a competitive fashion, it is unlikely to harm the economy at large. Though the proliferation of new financial instruments and the increased face value of these derivatives provides certain efficiencies on a day to day basis, it appears that the long run cost they impose outweighs the benefits. They decrease transparency and increase leverage: both effects increase risk, and the rewards previously reaped have not been close to commensurate--though it would require a huge econometric study to prove this claim I am making.