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:
- The various agencies currently tasked with financial regulation will fight tooth-and-nail to retain authority, despite having exhibited an utter inability to handle it. Any roll-up, single-authority that gets created -- if we even get that far -- will be just as inept and bureaucratically complex as the sum of its parts, if not more.
- If the government (via BASEL, SEC, Fed, Treasury, or whatever) mandates banks to maintain X metric at Y levels, the banks will simply create new mechanisms/products/avenues/etc. to game the system, allowing them to give-off the appearance of safety while still effectively maintaining -- or worse, increasing -- leverage and risk. I call this compliance by obfuscation, and I think there's more than enough, especially recent, historical precedent to expect the trend to continue.
- I'm astoundingly skeptical of the government's ability to establish, track, and enforce any policies that attempt to avoid and/or wind-down too big/interconnected to fail institutions. While Dr. Bookstaber is correct that giving regulators far greater pools of data and the tools to analyze them is a major step in the right direction, the G.I. Joe mantra -- "Knowing is only half the battle" -- seems to dictate such endeavors will inevitably fall short of regulators' best intentions. I loathe beating a dead horse, but if the SEC couldn't figure out the Madoff scam when the entire case was handed to them on a silver platter, I find it hard to believe regulators will be able to beat Wall Street at its own far more ambiguous and complex games.