"Though we're buying a financial stake, Paulson is not demanding a change in management, much less a say.

"He's not requiring the banks to halt foreclosures, or to freeze interest rates on subprime mortgages.

"And he's not requiring them to stop dealing in the derivatives and credit default swaps that caused the crisis in the first place, even though Senator Charles Schumer of New York urged him on Monday to ensure that the banks engage in "safe and sustainable, rather than exotic, financial activities."

Those pesky derivatives and credit default swaps, used to engender profits and cause this financial debacle, were completely unregulated.

Mike Lillis at The Washington Independent reports: "As Congress mulls how to buoy a sinking economy, lawmakers seem increasingly determined to rein in the unregulated derivatives industry, which many suspect has caused much of the mess.

"During two congressional panels convened this week, key lawmakers have vowed to push new regulations for the derivatives market, with a particular focus on complex instruments called credit default swaps, or CDS.

"Those swaps ”effectively private insurance contracts in which one party pays another when a third party defaults”are used by banks and other financial institutions to spread risk. Unlike insurance contracts, however, no one in Washington is charged with overseeing them. The practice has left trillions of dollars in exposed debts ”including mortgage-backed securities” in the hands of the same firms that are flailing under the current economic crisis.

"The lack of oversight, combined with the sheer complexity of the layered transactions, has left lawmakers convinced that new protections are needed, but unsure what form they should take. The agriculture committees in both the House and Senate took up the issue this week, because past deregulations of CDS had fallen under their jurisdiction.

" 'There is an estimated $55 trillion in credit default swaps somewhere out there,'  Rep. Collin Peterson (D-Minn.), chairman of the House Agriculture Committee, said Wednesday, 'but no one knows for sure if any of these swaps offset each other, exactly who is on the hook for these swaps, who is trading with who and on what terms. And worst of all, no one has any idea who is solvent and who is upside down.'

"The rise of CDS as tools of the finance industry has been meteroric. Lukken said the global notional (or face) value of CDS has doubled each year this decade. In 2007, according to the Bank for International Settlements, that value was roughly $58 trillion” close to the gross domestic product of the entire world.

"There's good reason for that skyrocketing popularity. First, CDS can be traded, or swapped, by large financial firms more easily than insurance policies can. And second, the buyer doesn't have to prove it can cover the risk if the deal goes south.

"The swaps were used by financial institutions to back their obligations ”including mortgage-backed securities” in order to make even risky investments appear healthy.

"Testifying before the House committee Wednesday, Henry T.C. Hu, a finance expert at the University of Texas School of Law, attributed the downfall of American International Group largely to its estimated $440 billion exposure to CDS. "It's hard to disentangle [AIG's CDS ventures] from the failure of the entity itself," Hu said.

"Both [acting chairman of the Commodity Futures Trading Commission.Walter]Lukken and [director of the SEC's trading and markets division, Erik] Sirri urged lawmakers to consider a model in which separate, global entities act as competitive clearinghouses. But that idea also raised concerns among some Democrats. Rep. Jim Marshall (D-Ga.) wondered how the competitive clearinghouse model would differ from the competitive swap model that many contend just failed. "It would potentially be another layer of lip-gloss," Marshall said.

"On Tuesday, Sen. Tom Harkin (D-Iowa), chairman of the Senate Agriculture Committee, held a similar hearing on CDS, concluding that legislation will be needed to rein in the industry.

" 'The credit-default swaps and derivatives have been put together by mathematics and physics geniuses, but carried out without an understanding of human behavior and market behavior," Harkin said. "We must have regulations that will protect the rest of the economy from the excesses of the financial markets.' "

And Tiny Revolution adds the finishing touches: "Robert Rubin opposed the regulation of derivatives when he was Secretary of the Treasury during the Clinton administration. Brooksley Born, head of the Commodities Futures Trading Commission, wanted to regulate them.

"As the world financial system lies in smoking ruins today, whose fault is it that derivatives weren't regulated? As Robert Rubin eloquently explains today, it's her fault:

"RUBIN: I do think it was a deterrent to moving forward. I thought it was counterproductive. If you want to move forward...you engage with parties in a constructive way. My recollection was...this was done in a more strident way."

Rubin, Lukken, Sirri and others of their ilk should should never be used as adivsers or allowed anywhere near government; they are dangerous and anathema to any 21st Century New Deal.