Does Financial Regulation Work?

According to its March 26, 2009 press release, the U.S. Department of Treasury advocates what they call "comprehensive reform" to modernize the U.S. financial system and seek to avoid major meltdowns. Key components include:

• Addressing systematic risk rather than focusing on "potential insolvency of individual institutions" alone
• "Strengthen enforcement and improve transparency for all investors" as a way to safeguard consumers and investors
• Create a "substantive system of regulation that meets the needs of the American people," avoid turf wars and "assign clear authority, resources, and accountability" to those in charge of enforcement
• Outreach to non-U.S. regulators in order to "address prudential supervision, tax havens, and money laundering issues in weakly-regulated jurisdictions."

For those who think this is all bark and no bite, consider that U.S. Treasury Department Secretary Geithner is calling for (a) registration of hedge fund advisers above a certain size, not to mention additional reporting requirement for said alternatives (b) "comprehensive framework of oversight, protection and disclosure for the OTC derivatives markets" (c) more stringent capital requirements for organizations deemed to be major financial market participants and (d) a single independent regulator to oversee "important" entities. Click to read "Treasury Outlines Framework for Regulatory Reform" (March 26, 2009).

Not everyone thinks that more regulation is smart regulation. During a recent interview with First Business, hedge fund consultant Kristin Fox voiced two problems with a regulatory power grab. Enhanced disclosure may lull people into false security, discouraging them from probing further. Additionally, regulators may struggle to understand the economics of "complex" instruments. Click to view "Financial System Overhaul," written by Beejal Patel (March 26, 2009).

Let me ask what may seem like simple questions.

• Wasn't the Basel II Capital Accord supposed to derisk the global banking system by imposing more rigorous capital requirements?
• How is new regulation going to compare with this global initiative in terms of improving things? Click to read "Basel II Capital Accord, Basel I Initiatives, and Other Basel-Related Matters," part of the Federal Reserve Board website.

The point is that we've had more than a trivial amount of regulation in place for years yet we've still had problems. How are new mandates going to trump existing rules?

Comments

[john s. gordon:]

'regulation in place' during 2001-2008 did not mean that anyone was actually regulating anything.
the policy of the bush white house was to not regulate.
> jack

Mar 30 08:12 AM

[Vuke:]

Regulation, with its extensive detail, provides one unexpected result. That is, while providing comfort for the investor and the industry, it creates a perfect roadmap and umbrella for crooks.

A better approach would entail more personal accountability in the handling of investor funds by opening all involved to recovery of recklessly lost monies. Nobody should walk away from financial fiasco with stuffed pockets.

Mar 30 08:31 AM

[One Eyed Guide:]

John's right - you have to enforce in order to have good regulation.

The fact that there were regulations that were selectively enforced just shows the falicy of "deregulation" and the unrealistic nature of Austrian economics. There are going to be regulations therefore any pure free market based economic theory that advocates degegulation will not work. Even enviromental regulation will distort a free market system enough that it won't work.

The other fact that justifies proper regualtion is that goverment is required, to paraphrase Thomas Paine, by the "evil" of men. Men will cheat and therefore there have to be regulations to keep them from doing so.

So, if the purpose of regulation is to keep men from "cheating" and lowering growth rates by distorting the market, regulations should ensure a fair market place.

The hard part about regulations is making sure that it only enforces "fair market" rules and not some political or economic bias.

Mar 30 08:42 AM

[MikeOz:]

I think you only have to look to the north to answer the question in your last paragraph - ie the current mortgage delinquency rate in Canada v that in USA. There's a similar banking regulatory environment in my country (Australia) to what exists in Canada, and currently we don't have any banks making a loss, let alone having their entire capital base wiped out. Admittedly we are in a quiet part of the world and our banks are boring (due to the regulatory situation), but at least they haven't to date needed bailouts .. though all bets are off of course if World Depression 2 does come to pass.

Mar 30 08:44 AM

[Allan Frain:]

Calls from Geithner for regulation while siphoning off sovereign wealth to the most eggregious cannot be taken seriously. His flip-flop on Global Currency revealed his disingenuousness.

Mar 30 09:23 AM

[Responsibility:]

When regulations don't work, the responsible people should be identified. The key point is not so much as more regulation, but more responsibility and accountability to support the regulations.

Let take a look at a description on credit risk (there are many other risks similarly defined) from the mentioned existing regulation document:

"• Credit risk: A bank should have the
ability to assess credit risk at the
portfolio level in addition to the
exposure or counterparty level. In
making this assessment, the bank
should be particularly attentive to
identifying any credit risk
concentrations and ensuring that their
effects are adequately assessed. The
bank should consider the various types
of dependence among exposures, and
the credit risk effects of extreme
outcomes, stress events, and shocks to
assumptions about portfolio and
exposure behavior. The bank also
should carefully assess concentrations
in counterparty credit exposures,
including those that result from trading
in less liquid markets, and determine
the effect that these exposures might
have on capital adequacy."

Apparently, the bank and financial/governing institutions have not fullfilled their responsibilities in accessing and taking appropriate actions regarding credit risks. With this as one example, shouldn't we need regulations to hold people accountable for in-appropriate risks taking with other people's money, instead of turning a blind eyes when they continually award themselves with high salaries and bonuses?

Mar 30 11:14 AM

[axelrod608:]

I think we can all agree that the current financial meltdown was caused by derivatives. Clearly, derivative financial products were devloped and sold that carried high risk and little backing. So it's not a matter of reglate or not, it's a matter of finding regulatory methods that work.

One system that does work (so far, cross my fingers) is the reserve insurance industry, where all products must be approved before they can be sold. Most of the toxic derivatives would never have been approved.

Credit default swaps are nothing more than insurance without reserve backing. Ask AIG - they know. Hell, ask a taxpayer - we know.

Another aspect of the reserve insurance industry is that if any company becomes insolvent, the assets are given to other companies who assume responsibility for the insolvent firm's policies. Voila - no taxpayer assistance required. And, if the big financials knew they would have to assume the liabilities of their fellow institutions, they'd scream bloody murder if one company was running their business like a casino.

And finally, it's time to stop hiring novices to do "investigations." Madoff's investigators could have, should have nailed him. Let's get some real sharks and pay them a percentage of the settlement. They won't miss anything. Time to put the "force" into enforcement.

Mar 30 12:03 PM

[henarl:]

Great ideas from axelrod!

Mar 30 12:49 PM

[Tom Armistead:]

Agree with John Gordon, regulations are useless unless they are enforced. The Bush administration for ideological reasons deliverately refrained from enforcement, particularly the SEC, which was worse than useless.

Also, good point from axelrod, derivatives are the source of the problem: specificially CDS which were exempted from regulation by Congress. The answer is simple enough, regulate them as insurance with a requirement of insurable interest on the part of the buyer and adequate capital on the part of the seller.

Mar 30 01:11 PM

[john s. gordon:]

vuke -

you are correct that a regulation (especially if written in fuzzy bureaucratspeak that obscures rather than obstructs) shows the unscrupulous where the flaws & crevices are.
the analogy is in the world of patents - a patent is a teaching tool, tells you if you do 'this' you will get 'that'. the infringer can go a little bit beyond the claims allowed by the examiner, and then dare the patentholder to sue for infringement. this keeps a lot of high priced lawyers busy/
> jack

Mar 30 01:22 PM

[PainfullyAware:]

Regulation Means Nothing Without Enforcement.

When the Government and Industry use accounting standards that have "No Off Balance Sheet Assets" many "Economic Ills" will cease.

It is much harder to pretend with full accountability.

Mar 30 02:46 PM

[Repsonsible...:]

Watching CNBC with AIRHEAD Burrnett , had a CEO on saying my company will Improve greatly this year , well ya its DOWN 94% last year . Then she interviews some banking talkng head says the Banks are in GREAT shape making a fortune . Then why will they still need MORE Taxpayer money And what does she do? nods knowingly , she is a JOKE! These People could tell her the worlds flat and shed nod her sillly head. I dont know WHERE they got her or whos daughter she is at GE but they NEED to GET RID of her , let daddy or whoever pay her allowance but get some one with a Brain who can ask some intelligent questions of the guests.

Mar 30 02:55 PM

[Buckoux:]

john s. gordon: "...the policy of the bush white house was to not regulate."

One Eyed Guide: "John's right - you have to enforce in order to have good regulation."

We are not an "enforcement" society any longer and have not been for a very long time. That is why more regulation will not be a solution unless existing and previous regulations are revisited, revised and enforced.

We have not enforced our immigration laws because it will hurt someone's feelings or reduce the opportunity to mine these ethnic groups for political support by big government and cheap labor by big business.

We do not enforce, heretofore, "good" public health policy because some group might become offended and have their "libido" diminished.

Pick any calamity that has befallen the USA for the last 50 years and you will find the lack of enforcement of existing regulations to be the open door for the "bad actors" of that calamity. Whether it's the AIDS virus, Arab terrorists, or financial larceny (corporate, private or political), the timidity of government to enforce effective regulations, and business to abide by these regulations, have all been a partners in these crimes.

Hollywood (big business) gets better enforcement efforts of its anti-piracy laws from the FBI and Congress (big government) than did any pre-9/11 airline passenger from the FAA, or the owner of a 401K from the SEC since 1998, or a hemophiliac from the FDA. This government and society, of and by the Baby Boomer's, has been a sorry feckless mess. (spit!)

Mar 30 03:51 PM

[AndrewBaker:]

Address risk, provide transparency, and meet the needs of the American people: great: so that's why the powers that be colluded to get AIG bail-out funds handed to the banks to dole out so that financial and other shares shares would be bought at excessive prices to stimulate a false bull market. Maybe my ideas about risk, transparency and the needs of the people do not agree with Washington and Wall Street.

Mar 30 04:02 PM

[Repsonsible...:]

Dylan Ratigan was FIRED by CNBC excs last week after saying on air that the AIG Bailout money was basically given over to Goldman Sacs to payoff there CDSs at 100% on The Dollar !
So for speaking truth to Power he was fired and looks like Banished from the World of Broadcasting . I Wish Him Well he was the REAL DEAL !

Mar 30 05:21 PM

[Lamont B Du...:]

Oh goodness gracious, a hedge-fund consultant thinks financial regulation is bad! Next let's ask a fox if he thinks the egg-farmer should get a dog and a convenience-store robber what he thinks about putting more cops on the street.

Despite the terrified predictions of financial industry-types (aka "the people who got us into this mess"), no one is suggesting that a government bureaucrat should be back-seat driving. All we want are some traffic signals & speed limit signs. And yes, those regulations should be enforced.

Jon Stewart got it right; those guys were running a casino using our 401-Ks

Mar 30 06:52 PM

[vaultvix:]

The Germans are the most vocal about the desire for increased regulation. So, please, help me understand this. Will this new regulation have limits on the percentage of assets of the Hungarian banking system that will be permitted to be in Swiss Francs? Will it limit the percent of the Landesbanks' securities portfolios that can be invested in California real estate securitizations since their funding comes from local Euro-based sources? Will it have the ability to recognize problems that are arising? Or are they just deciding that if they require more capital, they will have more room to absorb mistakes like this? Just asking.

Mar 30 07:19 PM

[Blackeyebart:]

This is the result of weak regulation: No-one trusts anyone. The Banks don't lend. Credit is reduced. Fear drives treasury rates down as investors huddle under the Government umbrella. Markets collapse. Companies sales figures tank. Countries with conservative (strong) regulations are boycotted.

Sensible regulations help investors, but Investors will fight all regulations every step of the way.

Mar 30 08:04 PM

[Mr. Fusion,:]

On Mar 30 03:51 PM Buckoux wrote:


> We are not an "enforcement" society any longer and have not been
> for a very long time. That is why more regulation will not be a
> solution unless existing and previous regulations are revisited,
> revised and enforced.

Where I disagree is that we "selectively" enforced for the past seven years. People got enforced. Businesses didn't.

Medical marijuana users got the same DEA harassment.

Speeders got pulled over just as much.

Air passengers were way more regulated (did that make you feel safe?)

But big businesses were less regulated.

Imported food and toys wasn't inspected. Domestic food wasn't inspected and the inspections that did occur were ignored by the political managers.

95% of imports are still not inspected except for their manifests but air passengers are still searched and refused on planes because they resemble "a terrorist".

When we saw problems in the financial sector, the regulators accepted that the offender would fix the problem or even that there was no problem. Madoff, AIG, CITI, and others all gamed the system knowing the regulators were in their pockets because they had paid their political bosses off.

Mar 31 07:47 AM

[coloneldebu...:]

Over the last six months or so we got a good view of what less regulation will get us. Chances are pretty good that unless we hear the financial gang bitching and complaining about any forthcoming changes the changes won't be strong enough.

Apr 03 12:42 PM

[morph366:]

For regulators to work effectively and be staffed by the brightest and most wily (not always found in the same person) the regulatory agencies will have to offer much, much larger compensation packages.
It's a battle of wits at the end of the day - and if we want to have an innovative financial services industry which has high rewards then they will continue to outfox the regulators unless the regulators can reward commensurately.

Apr 04 07:08 AM