Does Financial Regulation Work?

by: Susan Mangiero, CFA

Click to enlargeAccording 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.

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?