New Financial Regulation Is Only Half The Battle

Several other observers have written at length about the sort of financial regulatory reform the U.S. needs to adopt in order to achieve sustainable health.  In general, recommendations tend to include big-picture concepts. While I think all of these goals are admirable both individually and as a whole, the devil is, as always, in the details.

Here are some of the kinds of concepts being discussed:

- Unifying regulatory/enforcement authority under one office, as opposed to the hodge-podge, over(under?)-lapping hierarchy we currently suffer from.

- Increasing bank capital requirements to cushion against tail/systemic risk.

- Establishment of resolution authority to wind-down institutions that are (or are becoming) too big or too interconnected to fail.

- Creating policies to reduce system-wide moral hazard (and means of forcing adherence to them in times of stress).

- Establishment of a consumer protection agency/authority.

As mentioned, such ideas sound pretty good. But in this author's semi-humble opinion, our government has proven, beyond a shadow of a doubt, that it cannot even enforce existing financial regulation.  What, then, leads anyone to believe any new-fangled regulations will be enforced with much greater success?  Similarly, the government consistently adopts regulations and policies that, once Wall Street figures out how to bend the rules, end up having more holes in them than Swiss cheese.  Why, then, should we expect it to be different this time around?

Back in February, I was lucky enough to attend a FT Alphaville event, headlined by Richard Bookstaber, a man far, far more intelligent and accomplished than myself.  It was at this event where I argued (or attempted to, that is) that no matter how much data we provide regulators, no matter how well-intended the laws and policies, until we address the massive, myriad incentive structure asymmetries between Wall Street and its regulators, nothing will change.  Unfortunately, I doubt my argument stuck much in the head of Dr. Bookstaber or many of those in attendance, but I have, and continue to believe my point to be as true now as ever, even though the SEC actually (a step in the right direction!?) hired Dr. Bookstaber as a Senior Policy Adviser to the Director in the newly-established Risk, Strategy and Financial Innovation division. 

How, prey tell, should we expect regulators to out-smart (or out-whatever) Wall Street? The latter hires the best & brightest -- and pays them accordingly -- while the former hires those who couldn't get jobs with the latter, and pays them accordingly, the few recent additions aside?  

I posit that so long as regulatory agencies -- and employees thereof -- suffer from paycheck envy, regulatory capture, institutionalized bureaucracy (too many masters and conflicting goals), etc., we're crazy to think there's one iota of a chance that government will be able to rein-in Wall Street's opportunistic ways.

Call me a cynic, but for each of the bullet-points above, I can imagine less-than-ideal, yet highly likely outcomes, respectively:

Presented by

Jordan Terry

Jordan S. Terry is Founder & Managing Director of Stone Street Advisors LLC, which provides independent financial research & analysis services to institutional investors.

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