Derivatives, those fancy financial instruments that were intended to reduce risk but according to Warren Buffett have turned into weapons of mass economic destruction, are now in the cross hairs of the Obama administration. The government has announced it is seeking oversight of this previously unregulated sector of the financial market.
Those in the know say the new regulatory structure will have four objectives: to reduce unhealthy trading practices, to promote more efficiency and transparency, to discourage market manipulation and fraud, and to protect investors. Gee, shouldn’t honest businesses be doing these things anyway? Especially when large amounts of money are at stake?
Far from being a regulatory straight jacket, these objectives appear to be nothing more than a codification of prudent, sustainable business practices. If the proposed regulatory objectives are so obvious, it also makes you wonder why some existing law doesn’t already apply to derivatives and how such a big chunk of the financial market could be unregulated.
To understand how this could occur, it’s helpful to look at the relationship between ethics, public policy and the development of the rule of law. Ethics represents society’s expectations and public policy, the embodiment of those expectations, is ultimately expressed as a rule of law. It’s a dynamic process, a constant feedback loop.
When our sense of ethics is violated or offended the resulting public outcry crystallizes public policy and triggers the lawmaking function. It’s that simple. As a result, the legislative and regulatory rule making process is a reactionary response — and therein lies the lesson of derivatives.
If the companies and the traders responsible for the derivative debacle had only done more of what they “should” have done instead of what the law allowed they wouldn’t now be staring down the gun barrel of future regulation. They behaviors would not have triggered a legislative reaction.
When ethics are compromised and the equilibrium between ethics, public policy and law is violated, the disparity eventually surfaces. It’s just a matter of time. That’s why stretching the law and exploiting perceived loopholes can be short-sighted, especially if the letter of the law and the spirit of the law are not in synch due to clumsily drafted laws. It doesn’t fool anyone, causes harm, and ultimately results in more pesky laws aimed at filling the gaps.
That’s why good companies follow the letter of the law and excellent companies follow both the letter and the spirit of the law. Excellent companies appreciate the long-term value of self-policing, self-restraint, and integrity.