Either way, I absolutely agree that Exciting firms are going to attempt synthetic versions of many of the services provided by Boring institutions. Assuming that there continues to be more capital in the unregulated than the regulated sector, these synthetics will probably have cost advantages over the CFPA-approved vanilla offerings from the Borings. I would not stop this, except insofar as I would not allow unaccredited investors access. You place your bets and you take your chances. For what it’s worth, I don’t consider a leveraged ETF (a security with downside limited to the quoted value) to be analogous to direct shorting with leverage (a security with downside limited only by capital adequacy of the investor).

As for the money markets, I think it was a horrendous decision to intervene. Every single money market investor had the option to invest in Treasuries and declined in favor of the higher yield available from short-term financial institution bonds. Every dollar of higher yield was paid in respect of the higher risk of those securities – the small but nonzero risk that one or more of the financial institutions would not survive 90 days. When that rare event happened, it was of paramount importance that the investors lose their investment; what else would be the point of holding short-term Treasuries?

The Serious wing of the Democratic party dismisses moral hazard as blithely as the crony capitalist wing of the Republican party dismisses deficits; a nice concern when things are going well, but the first scruple jettisoned in times of trouble. Both are terribly short-sighted.

A secondary concern is the difficulty in sustaining barriers. There’s going to be a differential return between the two types of finance (boring will get a lower return, one might expect), and that’s going to create a strong pressure for arbitrage. And arbitrage means innovation! Someone’s going to create a vehicle that is designed to evade the regulation – consider how triple leveraged ETFs that are bought/sold like stocks open up leveraged shorting to retail investors. Are we going to have an active/energetic regulator to stop this?

Or consider an even more prevalent form of arbitrage. Money markets, which were supposed to be as safe as cash. Would these be outlawed in Boring companies? In terms of the panic, the seizing of short-term paper markets when money market funds invested in short term lehman paper vaporized was partly what triggered the LIBOR spike and credit seizing. This shock then reverberated through the system. But, arguably, short term lending to stable companies to meet payroll (AIG looked stable… so did others) might be a Boring function.

As for the Taunter universe, under my rules the corporate form would be irrelevant. If Goldman – or any other firm – wanted Boring status it would need to divest ALL non-Boring activities; that’s the point of barring any and all common control with Exciting firms. And once it had Boring status, it would essentially have the 10% Tier 1 ratio thrust upon it, because the moment it went out of compliance the cramdowns would begin automatically until enough debt had been converted to make the ratio.

To the extent that Goldman – or any other firm – decided to stay Exciting, it would be barred from any Federal intervention: no Federally-backed debt, no good/bad structure, nothing.

However, I would point out that even the crony capitalist Bush/Cheney administration – America’s Suharto – declined to bail out Enron when the Crooked E failed. Enron was a massive company, and in essence it was simply an Exciting firm with a few power assets.

If Boring firms were well-insulated from the Exciting firms – preserving this insulation is why my proposal bars Boring firms from even investing in the securities of Exciting firms – the failure of Exciting firms would only strengthen the Boring firms. Furthermore, the government could justly say that the Exciting firms were only playing with knowledgeable investors’ risk capital and got what they deserved.

Only Boring institutions can lend to small businesses (non-accredited investors). So all small business loans are CFPA-approved transactions.

Accredited investors that have a corporate form are free to borrow from Boring institutions as well. In this case they receive the same CFPA-approved vanilla deals, and enjoy the soundness of a well-capitalized counterparty and the fact that the government will intervene to maintain the well-capitalized nature of the institution.

Alternative, accredited investors may deal with Exciting firms. The Exciting firms may be able to create more exotic bespoke deals that lower the cost of capital for the corporation. The corporation needs to balance the benefit of receiving a better deal with the cost that if push comes to shove, the government absolutely will not intervene to save the Exciting firm.

Should the corporation decide it wants the extra risk for the better pricing, it has to live with the consequence that things will not work out as planned. Indeed, one of my major objections to the government intervention in the money market fund world last September was that there was always a government-backed option for parking money – the Treasury market. People who invested in money market funds were chasing the higher yield of bank securities; that higher yield was attached to the risk, however remote, that the banks would fail. When the banks failed, that risk should have been borne by the investors.