Illustration by Topos Graphics
Illustration by Topos Graphics

The financial markets need regulation the way a nuclear-power plant needs a cooling agent for its radioactive fuel rods. If safety rules are enforced and the heat of the rods is properly controlled, the result can be clean, abundant energy. But if that cooling process is neglected, there could be a meltdown.

Similarly, capital requirements are the cooling agent of risk-taking in the economy. And just as nuclear fuel will always be reactive, people will always be greedy. We need to enforce rules to balance natural greed with capital requirements so that greed can create productive risk-taking and competition -- not short-term extraction. Here are five possible ways to do that.

Make Swaps Public: In Las Vegas, you need to have actual money to gamble -- your own money -- and if you lose, you pay. But since 2000, banks, industries and consumers have been free to take on system-threatening levels of debt (to the point of financial meltdown) without facing any requirement to risk a significant amount of their own money. And while consumer risk-taking was curbed by the 2008 financial crisis, U.S. banks continue to use America’s deposits insured by the Federal Deposit Insurance Corporation to fund their mad, bonus-seeking speculation.

Fed Borrowing

Once the banks blow through that, they borrow from the biggest money-printing house in the world: the U.S. Federal Reserve. No one else in the world can pay themselves billions to take enormous risk with little or no money down.

To end this insanity, the American people must demand an end to the anachronistic “dark market” for credit insurance, or swaps, and insist that they be moved to an exchange where the risks that we all now bear can be visible to all. All trades on the exchange must be required to meet capital requirements (or some equivalent inhibitor of risk) to stop this reckless behavior for good.

Perhaps as important as the integrity of capital requirements is the visibility that an exchange would create: We could all see who was trading and insuring what. One of the greatest obstacles in resolving the financial crisis in 2008 was the need to pay all the $600 trillion in swaps because central bankers couldn’t see which swaps were legitimate insurance for energy and commodities -- insurance that was essential to the economy -- and which were idle speculation.

Because the central bankers couldn’t see the difference, they were forced to pay off everybody, including the reckless speculators. The same thing happened in the European bond market in 2011. Home lending also needs additional capital requirements in the direct home-lending and consumer-credit markets for both private and government banks, such as Fannie Mae and Freddie Mac. Every loan must require a down payment. All lenders must be at risk for losses from their loans.

Cancel Speculative Debt: Some of the promises that were made in the days of reckless gambling and irresponsible reliance on taxpayer money can’t be kept. But as Mohammed El-Erian, chief executive officer of Pacific Investment Management Co., told me, “The question is, how do you share that burden? So far the burden has been felt mainly by the real economy and households.”

Ordinary Americans have paid for bankers’ mistakes. But while U.S. homeowners are under siege by creditor predator banks, and millions of unemployed debt holders are forced into a Survivor-like fight with one another over scraps, bondholders have been paid 100 cents on the dollar with newly printed money. Banks have been bailed out with printed money. The real sacrifices have all been made by ordinary people in the forms of increased public debt, reduced pension payments, and fewer health benefits.

Capital Requirements

We must require not only that banks retain more capital, but also that when they place bad bets, they pay the price for their losing bets themselves. Otherwise we are stuck with the worst of two economic systems: Like a capitalist country, we have private banks that keep their profits. But like a communist country, we have a system where banking losses are charged to the government. Only when we end this corporate communism will we realign the interests of the banks with the investors they serve.

The way to do this is debt reduction or cancellation. If the system is so out of control that we can use a computer to fabricate trillions in new money by simply adding some zeros, then surely we can find a way to delete some zeros as well. By definition, if you can print it, you can cancel it.

A swap can either be an insurance policy that helps to lower long-term costs for a business or a bet by an outsider on whether a given company or country will succeed or fail. Putting swaps on a public exchange would create the visibility for all to see the difference between commodity insurance that is critical to the economy and speculative bets that are not much different from gambling.

In fact, Richard Grasso, the former chairman of the New York Stock Exchange, suggested to me that the speculative bets that fueled the financial crisis could be reclassified legally as online gaming -- and then canceled. His technical explanation: “I believe regulators should require the product to be registered with a central clearing agent (like an exchange) and thus able to be monitored globally to prevent contracts being written in excess of the debt obligations they are designed to insure (corporate or sovereign). This is easily accomplished by [regulators] and Treasury issuing a cross-markets rule adopted by non-U.S. counterparts. Any contracts written outside these requirements would be deemed null and void by regulators as simply online gaming.”

Tax Overhaul

Revise the Tax Code: It seems to me that if we agree that there’s nothing morally wrong with getting rich or being poor, and that we want people to use their wealth in ways that increase productivity, then that’s what our tax code should encourage. Maybe we should tax spending -- consumption -- rather than income, and let the tax code discourage short-term investors and reward long-term investors. If you find a way to use your computer to extract money from the stock market in a few seconds, you should be taxed very high. If you commit your money for years, launch a business and build something new that others can use, you should be taxed low.

A well-run country is like any well-run business: greedy, but long-term greedy. We need a tax code that will bring out the “long-term greedy” in every American.

Contain Wall Street: The basic secrets of the derivatives market are now known, but the crisis was not caused simply by a failure of understanding. It was caused by a failure of our political system. In 2009 alone, banks spent $220 million lobbying against new regulations such as capital requirements and lobbying in favor of spending cuts to get budget deficits under control. But as Simon Johnson has written, “[The banks’] rhetoric is misleading at best. At worst it represents a blatant attempt to shake down the public purse.”

When the political conversation turns to debt, it usually hides the reasons we ran up this debt and the fundamental culpability of the greedy bastards on Wall Street. When Wall Street isn’t buying access to our legislators, it is buying the very ratings companies relied on by pension managers to evaluate how risky a given investment is.

Wall Street banks pay Standard & Poor’s and Moody’s to rate their bonds. The better the rating, the more the banks can sell, and the more money that ratings companies and banks make. But considering the massive risks given to the world’s pension and insurance managers by Wall Street and the ratings companies, shouldn’t the risk evaluation be paid for by the group buying the investment -- not selling it?

Call a Reset Meeting: Historically, debt-reset meetings have come after major conflicts such as World War II, World War I, and the American Civil War. In these meetings, governments realigned the interests of countries and financial institutions using tools such as infrastructure banks (which provide temporary lending when private institutions no longer can), tax reforms, debt cancellations, and new banking regulations. I suspect, however, that many of us would prefer to skip the war and just fix the problem. We cannot allow giant creditors to turn fights over debt into currency wars and then real wars. Our opportunity in this generation is to resolve the global debt imbalance with a new Marshall Plan before a war begins.

(Dylan Ratigan, the former global managing editor for corporate finance at Bloomberg, is the host of MSNBC’s “The Dylan Ratigan Show,” and the author of “Greedy Bastards: How We Can Stop Corporate Communists, Banksters, and Other Vampires From Sucking America Dry,” to be published Jan. 10 by Simon & Schuster.)

To contact the writer of this article: dylan@dylanratigan.com.

To contact the editor responsible for this article: Michael Newman at mnewman43@bloomberg.net.