Something has gone amiss when Blawgletter feels brighter on a subject than the brainiacs who write lead editorials for The New York Times.  Today's exception, we think, proved the rule.

The way-smart NYT editors yesterday penned a top-of-the-left-hand-column-just-below-the-masthead item that looked at holes in the bank-unfriendly bills Congress now has before it.  They opined that the draft laws won't do enough to curb contracts that do things like "bet on the mortgage market, in which one side was destined to win and the other to lose, without 'investing' anything in the real economy.  The C.D.O. [collateralized debt obligation] did not hold actual mortgage-related bonds, but rather allowed the participants to stake a position on whether bonds owned by others would perform well, or tank."  

And they concluded:

That is not investing, it is gambling, and it is abusive.  It has no place in banks that can bring down the system if they fail.

Since when, we wonder, did buying stocks and bonds become anything other than "gambling".  And how do we tell what Wall Street bet amounts to gambling and what counts as investing?

Our view tends towards a rule that presumes an unlawful motive for any derivative buyer who doesn't own an genuine interest in an asset whose performance determines the value of the derivative.  A derivative buyer who wants to hedge against a default on a "reference security" — the 1,000 North Texas Tollway bonds she holds, say — would get a Fast Pass in court.  But non-NTT bondholders who bet against the Tollway bonds without owning any would have to show, by way of defense, that they had a Good Reason for throwing the dice on their bet that the NTT bonds will default or otherwise trigger a bad "credit event", which would force the derivative seller to pay the bettor her winnings.

A Good Reason might include the fact that the derivative-purchaser owns East Texas Tollway bonds, whose fate closely tracks that of the bonds of its Dallas-area cousin.  It wouldn't suffice, though, that the buyer simply wanted to make out like a bandit if, as he hoped, NTT bonds crashed and burned.

If all this sounds odd, welcome to the wacky world of derivatives.  

But let's not think, as the NYT editors seem to, that banning "abusive derivatives" and prohibiting "gaming contracts" means anything without a rule people (i.e., judges) can grasp.  A law that grants a defense to those who can show Good Reason for buying a derivative, despite lacking an interest in the "reference security" it derives from, would go a long way towards killing "abusive derivatives".  It would give content to a bar against "gaming contracts", on Wall Street if not in Las Vegas.

We end by nothing, as we have before, that derivatives blossomed as a result of a law Congress passed in 2000.  The very last section of the statute, which hamstrung federal regulation of derivatives, pre-empted state laws against "gaming".  Which tells you all you need to know about derivatives.