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Thursday, August 14, 2008

"Bringing Back Regulation's Good Name"

This is from Felix Salmon (if you are unfamiliar with rules based versus principles based regulation, see here):

Bringing Back Regulation's Good Name, by Felix Salmon: Jesse Eisinger's column this month is about the different regulatory structures in London and New York, and how they both failed. I asked him about it... His rather excellent response:

...Laissez-faire regulation on both sides of the Atlantic has clearly failed. I'm trying to understand why and think about how to fix things.

Here in the U.S. the Reaganite experiment of financial deregulation reached its apogee roughly in the 2004 to 2006 period. That wasn't supposed to happen. The pendulum was supposed to swing back to a more regulation in the aftermath of the stock market bubble, the accounting fraud pandemic and the Wall Street research scandals. Yet after SOX was passed and the Spitzer-inspired reforms, The Wall Street Journal edit page and the US Chamber of Commerce et al spent years railing about the regulatory overreach. Sarbanes-Oxley purportedly was having malign effects on American competitiveness and New York was threatened by London and Hong Kong. We were strangling technological innovation. The reality is that we were blowing another bubble, while the SEC and the Fed shirked their regulatory duties. I have no doubt that a concerted regulatory effort starting around 2004 or 2005 to regulate mortgage lending and to examine leverage in the system would have helped enormously, had the regulators been given the mandate. But the Bush-era SEC and a Greenspan-led Federal Reserve had no interest.

One point about London, which I think is underappreciated in the States, is that they were running an even purer laissez-faire financial experiment. I was puzzled how that happened, but the reason turns out to be fairly obvious: The FSA, the British super-regulator, was created when the financial services industry was strong. And the British economy is even more dependent on the financial services sector than the U.S.

What's interesting is that even though we have two different structures and two different approaches, we both got into very similar problems. We have a deeply overleveraged financial system and a bursting housing bubble. ...

I think "principle"-based regulation is pretty much a crock. But it's beside the point. The "principle" approach is a euphemism for being hands-off. As you see from my column, the FSA has virtually no enforcement staff or budget. So the British regulators couldn't enforce principles if they wanted to.

I think we should stick to rules. Principles are what firms need to adhere to themselves, by creating internal cultures that respect the rules, the regulator, and their customers. For instance, some firms have in-house risk management departments that are the "risk police" and some have risk management sitting at the table as a partner. At the Risk Police firms, you push deals you can get away with. That's bad for the firms and bad for the markets. Our regulators could try to find ways to encourage the creation of internal cultures that reward high principles as well..

Regulators need to enforce the rules. This is the problem. It's been exacerbated by our ridiculously Byzantine regulatory structure. It's obvious to most people that we need a radical overhaul of our regulatory structure, but if it's not back by a regulatory attitude change then it will be for naught. ...

[T]he main point of the column is that regulators have to regulate. We need to bring back regulation's good name. ...

    Posted by on Thursday, August 14, 2008 at 11:52 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (11)


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