My friend Janiece just reminded me of one of the reasons I'm a small "L" libertarian: unlike the Ayn Rand fan club, I recognize the limits of the free market.
The free market is the best device ever invented for the fair distribution of goods and services. But the efficiency of the free market depends on several conditions, and one of those is the free flow of information, and relatively equal access of that information to all the players in the market.
I'm not talking about the fact that Proctor and Gamble does not disclose that Joy and Dawn dish detergent are based on the very same patents, and are likely almost identical, save for the price. If you fall for that, you deserve to give P&G a little more of your hard-earned money than would otherwise be the case. Marketers make a lot of money on low-involvement decisions. It's a sort of tax voluntarily paid by the unwary to maintain a free market that is not over-regulated. Not to mention that the law mandates that the patent numbers be printed on the bottle for transparency. What more do you want, someone to read it for you? Read the fine print yourself and caveat emptor.
But we all take a little more care with high involvement purchases, which are de facto the ones that take a significant chunk of cash to make. In those instances, reputable sellers make sure that all the information is available to the buyer. Investing should be one of those high-involvement areas where the market is forced to operate at great transparency. GAAP, fund prospecti, 10Ks and the like keep everyone honest.
Which is why derivatives bother me. I'm a relatively smart guy, I hold an MBA from a top school, and I'm pretty math-savvy. I damn sure don't understand how all the risks in derivatives are accounted for, nor how ownership of that risk is distributed. Given the implosion-prone nature of derivative markets, I'm pretty convinced those people who do say they understand such things really don't.
This is exactly analagous to the illegal practice of buying on margin. In a normal market where people are betting with their own money, prices reflect the wisdom of the crowd on the rational expectation of future cash flows from an investment. Rational people can spot bubbles and avoid them. Although irrational actors can temporarily distort the market, they generally get what they deserve when the market returns to its natural equilibrium.
When people are borrowing to make stock purchases, the information on the crowd's confidence in the solidity of the the investment (reflected in the price) is hidden, distorted, or completely absent. The market breaks down because information is no longer transparent. In a similar way, the inability to track risk and accountability with derivatives distorts the natural feedback mechanisms that allow the market to self-correct.
This is why we need regulators, despite the very real issues of regulatory creep and capture. It is in maintaining the balance of ideals and real-world issues when the system is stressed that one can separate the rational libertarian from, say, Ron Paul.