Science-writer Matt Ridley amusingly points out that genes are not there to cause diseases, even though they’re named that way. Arnold Kling points out that financial instruments are not there to cause risk. From The Proper Attitude Toward Financial Regulation:
Often, the goal of financial regulation is to keep certain types of securities away from particular individuals or institutions. This is based on the ‘folk finance’ view that risk resides in securities, as opposed to portfolios.In a previous essay, I mentioned economist Robert Shiller’s idea of creating a futures market in indexes of local home prices. That way, buyers of homes could hedge against the risk that they are buying into a bubble. However, most individuals would face stiff regulatory hurdles for setting up accounts to trade in such futures contracts. From the government’s perspective, it is just fine for you to buy a really expensive house ‘on margin’ (that is, using money borrowed in the mortgage market), but you would face strict scrutiny if you tried to scale back your risk by using a futures market!
Until very recently, banks and other financial institutions faced much tighter restrictions on the use of ‘derivatives’ (options and futures contracts on Treasury securities, foreign currencies, etc.) to hedge risk than on having large unhedged exposures to interest rate movements. Even now, the use of derivatives is considered suspect, although bank regulators have gotten wiser about looking at overall portfolio risk exposure.
When an individual or institution is discouraged from using derivatives, the effect is to deter someone from hedging a risk. As a result, a regulation that supposedly is intended to reduce risk-taking can have the effect of forcing someone to retain exposure rather than spread the risk.