Thursday, October 16, 2008

The Maturation of China . . . and the Limits of Capital Markets

Chinese regulators are moving to allow margin trading and short selling in China's stock market:

``We must pay attention to the risks involved when we pursue financial innovations,'' Shang said. ``China will study the links between innovation and risks from the financial crisis and the fundamental reason that caused the crisis.''

China's central bank is also showing off its learning curve:

China has already cut interest rates twice in recent weeks, and with the business climate worsening, many economists say a further relaxation of monetary policy as well as tax cuts and increases in public spending are only a matter of time.
Only time will tell whether they truly apply the lessons of the credit crunch. Human greed and hubris always find ways around regulatory mechanisms, so the key to effective regulation IMHO is to build capital markets that are as simple and uncluttered as possible. Maybe the ideal solution is to go no farther than allowing margin, shorting, and simple options in a stock market. Banning any more complex product or procedure will limit the damage that investment banking chicanery can inflict. Clear definitions of permissible securities will make garbage like swaps or bundled derivatives grab the attention of regulators and invite penalties.

Ban all derivatives! Who's with me? Let's hear it.

Nota bene: Anthony J. Alfidi is long FXI (with covered calls) at the time this commentary was published.