Professor Robert Schiller of Yale discussed some recommendations for financial reform of the excesses of recent years in the Washington Post:

To limit risks to the system, build better derivatives. Some of today’s derivatives — the complex bundles of toxic real estate loans that helped drag Lehman Brothers down — turned out to be “financial weapons of mass destruction,” as the legendary investor Warren E. Buffett warned back in 2003. The problem isn’t derivatives per se but a certain kind — derivatives that spun a massive web of over-the-counter contracts, relying on the solvency of countless banks and other institutions, and ultimately endangered the entire financial system when they fell apart. Some kinds of derivatives, such as those maintained by futures exchanges using procedures that effectively eliminate the risk that the other party in the agreement will default, are more useful — and far safer — than others. It is high time to redesign derivatives to avoid what Buffett called “mega-catastrophic” risks.

For some time, the nearly $60 trillion in credit default swaps have been an accident waiting to happen, and now that event has happened, aided and abetted by bad government policies. We certainly hope that the bailout buys time for fixing the problem.

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