Monday, January 7, 2013

Government Regulation - Are We Doing It Wrong?

Over the weekend, I found the time to read an entire article from The Atlantic. The article, titled "What's Inside America's Banks?", is an in-depth look at the financial disclosure statements of US banks (using Wells Fargo as a case study). It's enough to make most folks comb through their portfolios to make sure we don't own any bank stocks. It's well worth the time to go and read it.

Buried in the middle of the article is an interesting observation about bank regulation and its ineffectiveness:
Accounting rules have proliferated as banks, and the assets and liabilities they contain, have become more complex. Yet the rules have not kept pace with changes in the financial system. Clever bankers, aided by their lawyers and accountants, can find ways around the intentions of the regulations while remaining within the letter of the law. What’s more, because these rules have grown ever more detailed and lawyerly—while still failing to cover every possible circumstance—they have had the perverse effect of allowing banks to avoid giving investors the information needed to gauge the value and risk of a bank’s portfolio. (That information is obscured by minutiae and legalese.) This is true for the complicated questions about financial innovation and trading, but it also is true for the basic questions, such as those involving loans...(Today, big banks have to answer to a dizzying litany of regulators—not only the SEC, but also the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the newly created Consumer Financial Protection Bureau, and so on. The disclosure regimes vary, adding to the confusion. Banks confidentially release additional information to these regulators, but investors do not have access to those details. That regulators have these extra, confidential disclosures isn’t much comfort: given the inability of regulators to police the banks in recent years, one of the only groups that investors trust less than bankers is bank regulators.)...
Until the 1980s, bank rules were few in number, but broad in scope. Regulation was focused on commonsense standards. Commercial banks were not permitted to engage in investment-banking activity, and were required to set aside a reasonable amount of capital. Bankers were prohibited from taking outsize risks. Not every financial institution complied with the rules, but many bankers who strayed were judged, and punished.  Since then, however, the rules have proliferated, the arguments about compliance have become ever more technical, and the punishments have been minor and rare. Not a single senior banker from a major firm has gone to prison for conduct related to the 2008 financial crisis; few even paid fines. The penalties paid by banks are paltry compared with their profits and bonus pools. The cost‑benefit analysis of such a system tilts in favor of recklessness, in large part because of the complex web of regulation: bankers can argue that they comply with the letter of the law, even when they violate its spirit. (emphasis added)
Governance has always been, in large part, an argument about the limits and scope of regulation. We need some government regulation on private behavior (lest we end up with Russia's oligarchs), but how much is enough and how much is too much? This is the basic stuff of politics.

But at some point in the 1980s, the discussion shifted. In a brilliant piece of political jiujitsu, those who had previously resisted regulation (in this case, banks, but the same applies to many sectors) embraced it and began actively participating in the creation of more regulation. The effect of this is that we are now drowning in regulations (the article points out that the Glass-Stegal act of 1933 was 37 pages; Dodd-Frank is 848 and it's not remotely done - in the end, the necessary regulations will fill tens of thousands of pages), but they don't work. We don't trust banks or regulators; we don't trust Congress or the executive bureaucracies.

How did we come to believe that more (meaning more complex) regulation is better? There was no national conversation to this issue, no political debate. It's a belief quietly assumed, unexamined, in the back of our minds. Modern finance (or industry, or what have you) is complicated, we are told - so we need complicated rules. No one questions the equation, even as we collectively distrust the results.

The idea of making regulation simpler and easier to enforce isn't a new one, of course. Philip Howard made this argument in The Death of Common Sense: How Law is Suffocating America. Because we are a tribal culture, and because at the time we were in the midst of the Clinton Prosperity, his book was widely derided by liberals and Democrats as being conservative and reactionary.

Left-leaning Democrats would do well to go back and give him another look, or read any of his three follow-on books. While he doesn't connect the dots this way, the argument that he is making - that excessively complex regulation is strangling the US economy and society - is one that should find friends on both the right and the left. The "1%" megacorps and vampire squid financial institutions that the left so distrusts are well-served by the massive yet ineffective complex of regulations we have built to "try" to contain them.

Ultimately, we've allowed our representatives in Congress to get trapped into thinking that every legislative response must contain an encyclopedia of details to cover every eventuality - rather than allowing judgements based on common-sense rules that we all understand. We don't get the effects of regulation that we want, and we as a people are pushed further and further away from our governance system, which becomes so esoteric than only K Street lawyers can understand it.

So perhaps it's time to put away the tired and wasteful debate over "more" or "less" regulation and talk about something more important - what kind of regulation do we want, and what do we want it to accomplish? We might find, if we have that conversation, that we agree on more than we think we do - and that real solutions can be found that most of us can agree on.

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