The financial "reform" act under consideration in Congress is based on a mistaken understanding of risk and how people react when they think that they can't lose.  

With all of the sound and fury emanating from both Wall Street and Washington DC about "financial reform" and who is to blame for the current state of the economy, it seems proper to take a look at the one thing that has been ignored; the human factor in finance.  

This author has already discussed problems between law and human behavior in past writings. What Capital hill is now intending to do is make essentially the same mistakes all over again, just as it did with bank deregulation, the Community Reinvestment Act, and the recent Wall Street Bailout.  At the bottom line is the fact that people don't learn from their mistakes unless they have significant, lasting, and sometimes painful impacts.  Even today, they haven't learned the primary lesson of the Great Depression; that thrift brings better results than profligacy.

The central issue that has to be addressed in financial reform is risk. When a rational person bets at a casino they know that if they lose, the money is gone. In financial investing and speculation risk should be the same, mitigated by the fact that the investor/speculator can research the risk and potentially increase the odds of a win because of one underlying fact. Where they place their money and what happens with the underlying investment is not pure chance. A company with a good track record and strong fundamentals has an excellent probability of continuing success, as long as there isn't something lurking under the radar or appearing without warning, as did the recent BP oilrig explosion. It should be noted that some people with industry knowledge blame the explosion on a lack of proper maintenance, which may have contributed to the earlier BP refinery explosion at Texas City. This may not be a coincidence.

The risks involved in the real estate mortgage implosion of 2007-2008 were quite obvious to anyone who had their eyes open. Aside from the fact that the Bush administration had gone to Congress several times warning of the danger, other signs were everywhere. Equally important was another fact; no bull market last forever. Congress ignored all of this. Obviously, it was more important to line the pockets of the Fannie Mae officers than to protect the American People.

A rational gambler who knows the risk of losing will quit when they are out of money or when the risk is too high. An irrational financial speculator who is banking on Uncle Sam bailing him out doesn't quit. He (or she) continues to throw good money after bad. Particularly when they are being encouraged to do so by federal regulations in some sectors, and allowed to do so by lack of regulation in others. This was precisely what happened in the real estate implosion.

But the problem is not one of regulation alone. It is, again, one of risk. The bottom line is that Wall Street investment bankers must be required to bear the risk themselves rather than counting on Uncle Sam to bail them out. It is one thing for federal insurance such as SIPC to cover the accounts of brokerage clients against the broker's errors. It is another for the feds to insure the shareholders, officers and directors against their own miss- and malfeasances. It is likely that the people running Lehman Brothers counted on getting bailed out and were totally surprised when they weren't. But if they knew for an absolute and total fact that there would be no federal help, it is likely that they would never have become involved in such risky activities to the extent that they did.

The crash of 1929 was created in part by a large amount of money invested in an overly risky market containing over-valued securities. This is similar to putting too much money into over-valued real estate. True, there was no government bailout in 1929, but then the 2008-2009 bailout hasn't kept the economy out of a severe recession or depression, depending on whom you listen to. In the end, if there had been an absolute risk of total loss placed on the lenders; if there had been no possibility of Uncle Sam covering gambling losses and if there had been no opportunity for the original lender to sell off the loans in "grab bags" as most of the mortgage backed securities were, then they would probably have avoided the risk. The use of derivative securities such as the credit default swaps was an attempt to mitigate the risk, but it was not successful.

The 2008 meltdown should be a lesson to the Wall Street, but it will not be if the government steps in and says "we'll back your losses, no matter how big, even if we have to take over your operations." This is the attitude, currently displayed by the Democrat controlled Congress and it is not calculated to bring about the desired result. While it is certainly proper to regulate what types of activities home mortgage lenders can engage in, and whether or not they can sell grab bag packages of loans on the open market, the government must be absolutely clear on one thing; if the company takes on excessive risks and commits financial suicide as a result, there will be no government assistance to the company officers or shareholders. "Too big to fail" should be tossed out as a wrong-headed idea that encourages people to do stupid things.

As a subtext to this, reinstatement of the Glass-Steagall act, separating commercial banks such as Bank of America or Wells Fargo from investment banks such as Goldman Sachs, and restricting their activities accordingly would also be a good idea.

When people have to bear the risk of their own actions and decisions then, if they are rational, they will control the risk to acceptable levels and will do what is necessary to keep the company from going under. That concept must be the foundation of any meaningful financial "reform." To do otherwise is to encourage people to continue to make the same mistakes, believing that their rich uncle will make it all better in the end.