Fixing Derivatives and Short Selling

I'm not a big fan of government regulation. It's a necessary evil at times, but it should be a last resort.

We've been through a vast problem with derivatives, those arcane financial instruments through which people "invest" in anticipation of certain financial results. The problem is that supposedly conservative financial institutions got involved and wound up betting that certain outcomes were statistically insignificant. Those improbable events have come to pass and the banks and brokerages who became entangled are dragging down a system that the economy actually needs.

I think there's a simple way out. The IRS has a simple policy on gambling income. If you make money gambling, you must report it as income. If you win some and lose less, you're only taxed on the net that you win. But you have net losses, don't come crying to the IRS. There's no offset against other income for gambling losses.

Certain types of financial trades smell of speculation but can be reasonably included in regular economic activity. I may buy oil futures without actually wanting to take delivery. I may buy shares in a company I don't believe will ever make a profit, but which I think will look good enough that I can sell for a gain after three months.

But these are still legitimate, since the economy depends on people buying and selling oil and shares in companies. Other types of trades have no such cover. Consider futures trading on the Dow Jones Industrial Index. It's a simple gamble, entered into by two parties, about a future number. Not all that much different from the numbers racket that the Mafia used to run.

Or short selling. People who buy stocks may have different motivations, but the original issurance of shares and the subsequent trading of those shares is a vital part of capitalism. Short selling has no such purpose. The economy needs people to take chances that a company will succeed, but not that it will fail.

Without any government regulation, the entire problem could be fixed by having the IRS treat all gambling the same. It's much simpler than a transaction tax and avoids putting penalties on legitimate activity. But if I invest in DJIA futures or I sell Bank of America short, that's gambling and the normal IRS rules should apply.

It's always been obvious that when people say they are against drugs, they only mean drugs not manufactured by people with shares trading on Wall Street. The two most dangerous drugs in America are alcohol and nicotine. The worst form of gambling is derivatives. In both cases, Wall Street gets preferential treatment over the common man. We should level the playing field.