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Back then, it was easier to nod along with the likes of Warren Buffett, who dismissed derivatives as weapons of mass destruction, despite occasionally using them himself. Now, thanks to the Dodd-Frank Act, regulators are being forced to deactivate nuclear-scale risks that lurk in the $615 trillion notional outstanding derivatives market. No surprise, it's a complicated business -- more so than those like the Securities and Exchange Commission and the Commodity Futures Trading Commission may have bargained for. Everything seemed simpler last year when politicians excoriated Goldman, Sachs & Co. and their ilk as criminals, despite the fact that they long turned a blind eye to instruments they knew little about. Finally, they realized these instruments had to be regulated.

Today regulators are working to deliver a new set of rules on 30 different major categories of derivatives by July 2011 (for another perspective, see Rules of the road). Despite their fervor for the job, skeptics doubt they will succeed in eliminating systemic risk, given Wall Street's knack for finding loopholes. "Sometimes regulations actually promote the wrong behavior," says New York-based Zohar Hod, head of the Americas at Super Derivatives Inc., which provides derivatives pricing information. "It's the nature of Wall Street. It takes advantage of situations that are given to it."

Take the over-the-counter derivatives market. Under Dodd-Frank, this bilateral market will continue to exist -- meaning derivative products that can't be standardized won't be directly regulated. While these contracts will now have collateral requirements and new transparency rules, it's questionable how well this will be policed. In fact, no one knows how big the OTC market will be. There are suggestions that as much as 85% to 90% of the credit default swaps and interest rate swaps market can be cleared, but that sounds optimistic, particularly for CDS, considering how illiquid that sector is. Clearinghouses can't afford to back illiquid contracts.

Then, there's the cost. New York-based research firm Tabb Group reckons that moving all OTC derivatives to central clearinghouses would require additional collateral of as much as $2.2 trillion. In a December report, "The Global Risk Transfer Market," Tabb analysts say such costs could overshadow efficiency savings from clearing. That, others warn, might give banks the wrong incentive -- to steer clients toward the OTC market, where they have more control over fees and collateral. Some fear that another problem like American International Group Inc. could erupt this way. Regulators insist they'll be monitoring such risks. But how thoroughly? The CFTC has admitted that it needs 400 additional staff to enforce new rules. Then there are technology gaps. Tabb estimates that sell-side global banks spent $4.7 billion on risk management technology in 2009, while the total SEC and CFTC budget is $1.3 billion. "More shocking is the IT budget of the CFTC per the 2008 CFTC Performance and Accountability report," Tabb's "Digital Divide" report says. The CFTC report cited just $26 million, meaning bulge-bracket investment banks spend more than 3 times that amount each month on technology.

Then, there's the issue of divided oversight. The SEC will police security-related swaps like single-name CDS, while the CFTC will regulate everything else, including CDS indexes, which are baskets of single-name CDS. Who will analyze data for the broader derivatives market? Some put their hopes in the new Financial Stability Oversight Council, established under Dodd-Frank, that's meant to monitor systemic risk. But it has 15 members, each with different priorities. Will they be able to coordinate? As for the SEC and CFTC, even if they do work well together, do they have the right technology?

"All the data will be reported to regulators to seek out systemically risky situations. But the reality is that the technology required to sift through all this data is out of reach of regulatory budgets," says Tabb Group senior analyst Kevin McPartland. "Furthermore, just looking at the OTC derivatives of an institution won't give regulators a full view of the underlying risks. They need to look at everything on the balance sheet."

It's doubtful that will happen, at least for now, because of fiscal restraints. If regulators lack the ability to view and police the market as a whole, it's just a matter of time before the risks will fester again.