For clearinghouses to work, we must have regulation that challenges the way we think about them.

Matt Taibbi's latest article in Rolling Stone appropriately characterized the financial reform act as neither an "FDR-style, paradigm-shifting reform, nor a historic assault on free enterprise." While generally describing the act as a "cop out," he identified the Fed audit requirement and the Consumer Finance Protection Bureau as positive developments. But he viewed the requirement that many derivatives be cleared as "the biggest win of all." Alas, Matt may have been too generous, or at least premature.

Mandating clearing was a convenient and simple approach for Congress. The idea was to shift the basic derivatives trading risks in an appreciable percentage of the market away from the banks to reduce systemic risk. The problem is that very few people are equipped to understand just how the mandate might work in practice.

How much of the market? What are the consequences? I have not seen evidence that anyone on the government's side can answer these questions effectively. This is not intended to demean anyone's intellect. Clearing theory is complicated and arcane. It was always a backwater of finance and was taken care of by people at the clearinghouses and in the back offices of the banks. Clearinghouses were largely allowed to regulate themselves through a process of self certification. This limited the Commodity Future's Trading Commmison's practical involvement with the markets.

Then clearing became the centerpiece of derivatives reform. We decided to concentrate the most dangerous financial risks in the galaxy in a couple of organizations.

As fate would have it, I am one of the few people around who knows something about the clearing business and theory and is not employed by an investment bank or clearinghouse. At the end of my career on Wall Street, I was hired to perform a financial autopsy of the special purpose derivatives clearinghouse set up by California as part of an innovative power market structure. It had failed in the state's power crisis of 2001-02. Observing the tremendous systemic risk generated by using conventional clearing techniques for all but straightforward derivatives, I embarked on a seven year quest. I formed a company that designed a mathematical, IT and legal structure to provide a transparent and orderly system to manage the risks of those derivatives which shouldn't be cleared conventionally.

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Imagine my surprise when the banks decided against using the system. They preferred taking advantage of the opaque and chaotic bi-lateral derivatives market. The profit potential of the shadowy chaos outweighed efficiency, transparency and sensible risk management. At least I can claim to have been ahead of the times.

There are two dangerous forces at work in the endeavor to push derivatives into clearinghouses:

1) Concentrating risks only makes sense if the risks associated with the cleared derivatives can be adequately managed. There is no way to collect enough collateral to cover all potential losses if a derivatives trader defaults. The credit risk embedded in a derivative is, by definition, limitless. Clearinghouses use statistics to measure probable losses. They will require sufficient collateral so long as the statistical analysis reflects reality. The further a type of derivative strays from the standard, liquid markets, the less valid is the statistical measurement of risk. It appears that most people involved with the reform legislation thought "unclearable" transactions were only one-off deals with non-standard contractual terms. The far greater issue concerns commodity classes and financial indices for which statistical risk measurement is unreliable. Historical market data may be too meager or the daily volume may make predicted prices "untransactable." For certain classes of derivatives, statistical risk measurement is simply impossible, not just unreliable.

One might think that clearinghouses would only take on these types of derivatives if the risk of doing so were prudent. One would be wrong. A byproduct of financial deregulation is fierce competition among a handful of clearinghouses. Profit depends on volume. Even before the crisis, competition had already pushed clearinghouses to the edge of prudence and beyond. We cannot assume that clearinghouses will be rational or that the government, so invested in clearing as an answer to the derivatives dilemma, will enforce prudence. Sophisticated and well-capitalized banks recently evaporated because they transacted business that, in retrospect, made no sense. Why not clearinghouses?

The risk is that we revisit the world of "Too Big to Fail."

2) Dealer banks have enormous influence over clearinghouses because they can control volume. Of the two major US clearinghouses, the IntercontinentalExchange (ICE) and Chicago Mercantile Exchange (CME), ICE is more susceptible. After all, the banks created ICE, largely to compete with CME. But CME is under bank influence as well. ICE and CME raced to clear credit default swaps after the market collapse in September 2008. The ICE effort was successful, in part because the special purpose clearinghouse it set up agreed to give the banks a 49.9% share of the revenues. CME naively created a structure with a trading feature attached, assuming that real-time CDS price transparency would be an attractive add-on. The transparency feature angered the dealer banks, which were already inclined to prefer the ICE structure for obvious reasons. The dealers have largely declined to support CME's massively expensive effort. Privately, CME has vowed never again to take on a project that the dealer banks don't support.

Clearinghouses may take on derivatives imprudently, but the banks may use their influence to limit clearing. These do not balance one another. The banks might well support clearing of some risky derivatives and, at the same time, use their influence to resist clearing of other derivatives which should be cleared.

These pitfalls can be avoided. Regulatory implementation and oversight can establish defenses. However, the process must aggressively challenge conventional notions of how clearinghouses work. Most of all, the regulators and proponents of reform have to be aware that the banks and clearinghouses are not necessarily friends. The banks will try to use their superior knowledge, resources and influence to craft a structure that allows them to continue business as usual. I despair that there is no practical counterbalance to the banks, such as AFR and other public interest groups that were so effective during the legislative process.

It turns out that this part of financial reform is a marathon, not a sprint.

Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co.

The best way to fight a war is to outfit Americans with education, energy, health care, jobs, and the opportunity to succeed.

Reading Lynn Parramore's recent article comparing the frustrating congressional response to the fiscal crisis in education with the size and scope of military funding triggered a neural connection in my brain. To describe the insight which emerged, I must confess to some aspects of my personality which I rarely share with others.

You see, I suffer from a gender-linked affection for thousand page military histories. Worse, I must reveal a few encounters with the literary works of Tom Clancy. (I cling tenaciously to the defense that, each time, it was the only available option in the airport bookstore.)

Since the Revolution, there have been only three wars which posed an existential threat to the United States: the Civil War, World War II and the Cold War.  Note that the "War on Terror" is not on the list. It is not even a war. It is a police action to punish and deter domestic criminal activity which has extraterritorial features. (This might make Dick Cheney smirk knowingly, but it can't be helped.) It seems that we need it to look like a war, so we invaded Iraq and sent large numbers of troops and equipment to Afghanistan. The only existential risk is to our core values, which could be abandoned out of irrational panic. But that would be a self-inflicted wound, so I won't count it.

These existential wars were not won because of superior weapons and tactics. Sometimes the US had the upper hand, and sometimes it did not.  This by no means diminishes the valor of our soldiers, sailors and airmen or the strategic skills of our generals and admirals.  Nor would I ever suggest that we have a second class arms industry.  It is simply an observation that there was another factor that was far more significant to victory.

In the Civil War, the Confederacy had superior military leaders, most notably Robert E. Lee and his staff. The Union soldiers produced marginally better rifles, but this was not decisive. The Union's real advantage was its economy. It produced overwhelming numbers of weapons. The North's road and rail networks provided incomparable logistics capability. Employment opportunities and prospects for freedom attracted hordes of emigrants and former slaves, swelling the Union army's ranks. Northern shipyards were adapted to provide a navy which blockaded southern ports. Grant and Sherman did not defeat the Confederate armies with clever tactics. They crushed the secessionists with headlong assaults, casualties and tactics be damned.  The use of the brute force of the Union's economy achieved total victory and avoided a long guerilla war (advocated by Jefferson Davis) which would have killed and maimed many more.

The German military fielded better weapons, for the most part, in World War II.  Their tanks were larger and had greater firepower and armor. The individual soldier's arms were generally better.  Even their air force had some technical advantages.  The German general staff was talented, at least a match for Eisenhower, Bradley and Patton, notwithstanding Hollywood's account of history. The decisive event for the American military was the breakout from Normandy in the weeks following D-Day. It involved far higher casualties than the invasion itself or any other US action in the war, rates comparable to the Russian front.  Breakout was achieved by using overwhelmingly large numbers of (less experienced) soldiers, airplanes and (decidedly inferior) tanks.  America simply out-produced the Axis nations and overwhelmed them with quantity.  The same thing happened in the Pacific theatre and in the Russian campaign. The United States could replace naval losses while Japan could not. And it is a lesser known fact that the Soviet economy, in reality, out-produced the Germans, building many more tanks, trucks and aircraft.

Ronald Reagan did not win the Cold War with blustery speeches and aggressive deployment of Pershing and cruise missiles at NATO's frontier.  Mutually assured destruction meant that marginally superior ICBMs and generalship were inconsequential so long as the inferior Soviet missiles were sufficient to annihilate NATO. Even in the proxy wars, American weapons and tactics had mixed results. American air and sea power could not defeat the Viet Cong and the North Vietnamese. However, the Israelis overcame Soviet weaponry.  Arming the mujahedeen with Stingers worked in Afghanistan, but the Soviet Union was already doomed by then. It was hardly worth inadvertently spawning Al Qaeda as a byproduct. The AK-47, churned out by the Soviets in the millions, was far more significant to America's proxy opponents.  The Cold War was lost because the Soviet political system could not abide the wide distribution of information technology. As the American IT industry was re-defining a modern economy, the Soviet economy was sclerotic and outdated, frozen in the sixties. It collapsed from the strain of subsidizing its eastern European empire in an effort to maintain even minimal late 20^th century living standards.

Mr. Clancy's books, filled with patriotic valor and high tech weaponry, stimulate certain primal urges in much of the male minority of our population. It seems that some congressmen are fans. The military's budget, filled with lethal gadgetry, is politically sacred, subject only to pruning and shaping.  Its special priority is based on the belief, dating from the Second World War, that a well equipped and motivated military is the most important factor for our security. Perhaps Roosevelt was so inspiring, as he led the Allied armies to victory, that some of us still yearn for the heroic battlefields of his day.

History instructs us on military policy. Certainly, weapons, tactics and training are useful, but they are merely adjuncts to our primary advantage in warfare. History's real message is that an educated, healthy, egalitarian and productive population is our best defense against external threats. Funding education, energy, health care, the environment, industry and infrastructure is the most effective military expenditure of all.

It would make more sense if the defense budget, as we know it, were funded only after those needs were taken care of.

After all, it is a matter of national security.

Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co.