Speculators need to be reigned in (but not squashed)

Linda Beale commented (Angry Bear) on Darrell Duffie's defense of speculators' role in the financial system, and I felt compelled to offer another two cents. In his opinion published in the WSJ (Feb 24), Duffie cited standard arguments from economic theory. As far as that goes, fine: speculation is useful, and speculators have their place.

But what theory suggests that speculators require or deserve or ought to have access to credit that gets them to leverage (debt-equity) ratios of 20 or 30? Some staunch free-market advocates (although I am not pulling these words from Duffie's mouth) might say, "If the market gives them that kind of access, then it's OK; it must be efficient". BULLCRAP! The downside here is obvious: you can't get blood from a stone. So as long as the liability of bankrupts is protected by law, the leverage that speculators are allowed to take on should be regulated, as well.

In principle, I see no reason why speculators should be allowed to take asset-capital positions exceeding one. (Heh heh!) OK, that's entirely unrealistic, since we would be hard pressed to parse "speculation" from "investment". But only speculators (or very poor managers) pilot financial institutions with leverage exceeding 20 times capital. When institutions in such condition are large, they make the entire financial system more risky. (Note the conflict here with Duffie's emphasis on speculators' absorption of risk.) I have a hard time seeing that Duffie's arguments apply unaltered to these institutions. At the very least, they should be subject to the same sort of regulation that commercial banks are.