The financial system is in a mess, and it’s taken a toll on the markets and exchange traded funds (ETFs), among many other things. Financial regulation in our country, as a result, is facing an overhaul, and the Treasury Department’s Secretary Hank Paulson has just issued a report on the subject.

The existing political and regulatory regimes in place now contributed to our current problems, although they were intended as attempts to address the perceived problems of the times in which they were created, reports Lawrence B. Lindsey for The Wall Street Journal.

A "culture of corporate greed" is the rhetoric, and political figures have no place to point a finger, nor anyone have a need to blame. In an attempt to get the regulation perfect, the manifestation of the human condition is echoed throughout the markets.

The three rules to remember are:

  • Both markets and the political process are inherently pro-cyclical. When things are up, markets and politicians will push things to excess and vice-versa.
  • Politicians and the regulators they hire and delegate to will layer on new and sometimes mutually exclusive objectives for the financial service industry. This comes from the first rule, as Congress had no sooner set highly restrictive lending standards (after the Savings and Loan scandal), then they demanded an ease so that more people could get mortgages. Politicians may want things that are contradictory, hypocritical or infeasible.
  • Regulatory institutions created to carry out conflicting missions became entrenched, making any changes a political hot potato. Regulations should be clear, simple and transparent. This makes them less subject to market manipulations, and it is more important than institutional design.

Once this is all over and a new market cycle begins, will we learn the lessons of basic human behavior that led to this mess in the first place?

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.