We've often complained that regulatory generals are constantly fighting the last war. Following the accounting scandals that led to the collapse of Enron, we got Sarbanes-Oxley. And fear about hedge funds following the collapse of Long Term Capital Management led to calls to regulate hedge funds.
All the while, real systemic threats to our economy and financial system were being built right into the American dream by mortgage companies, commercial banks and investment banks. Our homes are now our hassles, and none of the sound and fury from the SEC, the Fed or Capitol Hill about financial regulation raised a peep about it until it was too late.
But what if this focus on regulations aimed at the last crisis is misplaced? That is, what if it basically isn't possible to regulate away the threats to our financial system because the rewards for risky behavior are just too great. After the jump, some thoughts from Graeme Yell of the Hay Group
Here's Yell arguing that rules, and attendant rewards for compliance and punishments for non-compliance, are basically hopeless at reforming finance.
Rules and regulations are little more than a form of incentive - the negative incentive of punishment for transgression.In the City, therefore, they also have to contend with a further challenge - the massive incentives provided by bonus schemes.
Which is more real to a trader, this year's bonus, and a new Aston Martin, or the abstract threat of future investigations?
Short of draconian measures, there is little hope of a regulatory framework competing to shape behaviour. How could regulation have stopped Jerome Kerviel, for example, who was driven only to 'be the best'?
So what is to be done? Yell is a good European, and so he thinks the answer is to control risk through institutional principals. "Our recipe for a safer financial system includes strong principles capturing hard earned wisdom and leaders who protect these principles against short term greed," he writes. We can't help notice that this raises the old philosophical problem of the "philosopher king." In short, the problem is two-fold: wise leaders with appropriate principals are few and far between, and the principals that accompany wisdom are not usually those best adept at rising to the top of institutions.
Which is simply to say, we might just be condemned to muddle through without some kind of technique--rules or principles--that will somehow resolve the permanent problems of modern finance.
Can we regulate our way out of a crisis? [Director of Finance Online]
Posted by guest , Jun 13, 2008 10:06AM
institutional principles <> institutional principals
discussion about risk associated with principals is a whole 'nother subject.
Posted by guest , Jun 13, 2008 10:11AM
Never going to happen as long as there are dumbass CEOs going around saying things like "I want you guys to be more like (insert name of profitable hedge fund)."
Posted by guest , Jun 13, 2008 10:15AM
Carney you been reading lately? Reading is for suckers!
Posted by guest , Jun 13, 2008 10:24AM
traders understand risk.
too bad they're a dying breed.
Posted by Anal_yst , Jun 13, 2008 10:33AM
I thought we'd long-ago established that Kerviel didn't lose that 7+bn (he prints it!), SocGen's hasty unwind took the credit for that f'up.
Also you miss the chance to take this another step further. Why not regulate banks/investment companies compensation schemes, or disclosure thereof?
Posted by guest , Jun 13, 2008 10:39AM
I didn't realize that hedge funds were regulated.
Institute clawbacks of ill-gotten bonuses. Problem solved.
Posted by guest , Jun 13, 2008 10:44AM
Who gets to regulate anyway? Lawmakers? They usually know very little about IB in the first place.
Then who's priniciples? Just force the industry to regulate themselves with the threat of government reform.
Posted by lemmerdeur , Jun 13, 2008 11:41AM
I don't understand why we can have leverage limits for commercial banks' balance sheets and equity accounts, but not all this other garbage.
Furthermore, if we could create a standard for calculating and reporting leverage, then investors could demand such metrics when investing in any kind of vehicle - SIV, hedge fund, whatever. You don't limit leverage, you just make it easy to identify. Then, when you lose 99.98% of your investment, you have only yourself to blame.
Posted by guest , Jun 13, 2008 11:48AM
@10:44 is on to something here. Lawmakers and their aides don’t know anything about anything so they write and pass these stupid laws aimed at prohibiting past conduct when everyone has moved on to some new action. So you regulate to prevent “Enron style” accounting when everyone has moved on to mortgages. They’ll still be regulating mortgages long after the market has moved on the next hot product. Lawmakers and regulators are always fighting the last battle instead of seeing what’s currently happening and/or looking to the future. It really should not have taken any prescience to see that there were troubles brewing in mortgage/real estate land when every Joe Schmo was going into real estate (either as buyer, seller, broker, flipper) or the mortgage broker business or structured finance. Maybe its time to have financial professionals as lawmakers, or working for lawmakers or in regulatory agencies. (I know there is no money in any of those pursuits but go after you’ve made your money). A case in point is the article in the Metro section of today’s NY Times about the head of the NYS Housing Finance Agency. Her training is as a lawyer. Shouldn’t a finance person run a finance agency?
Posted by guest , Jun 13, 2008 12:08PM
Carney is on a tear this morning, I think he's a still a little PO'd about people giving him shit yesterday about reading sports guy at work and posting on Dealbreaker.
How can we get Bess to post like this? Can dealbreaker start some kind of subscription service, proceeds of which will be used to buy Bess more adderol? think about it.
SMP
Posted by Anal_yst , Jun 13, 2008 12:10PM
@ 11:48
As you've pointed out, theres no monetary incentive in doing so, the politicking is annoying and tiresome, and you work with bigger idiots than you do actually working in finance.
Even if you've already made your fortune, why bother?
Posted by guest , Jun 13, 2008 12:22PM
@Anal_yst
That means someones going to have to get creative to insure that big gov doesnt come in to put a foot on someones neck.
Maybe a new agency thats private. Something that conspiracy theorists can write about in their take over the world blogs.
Posted by StMarc , Jun 13, 2008 12:32PM
Basic problem: Companies have a fundamental duty to shareholders to maximize profits within the law. I've heard company officers make statements about how they do business according to "ethical principles" that I was amazed didn't get them sued by the shareholders.
Granted, the company's charter and bylaws, and the business judgment rule, blah blah blah, put shareholders on notice that just because it's not BLATANTLY illegal doesn't mean management and the board are OBLIGED to do it if it would make money, but the burden of proof is always going to be on them to show that a lost opportunity shouldn't result in their getting fired at best and sued (or jailed!) at worst.
Put that together with the basic rule of human nature that says "it is easier to get forgiveness than permission, especially if you have a dump-truck full of money to help you pay for the forgiveness," and as prior posters have pointed out, all the regulation in the world isn't going to help much.
Or, as a memorable character once said, "Laws not make people nice."
M
Posted by guest , Jun 13, 2008 2:01PM
LTCM was 10 years ago, and the HF industry is still a regulation-free haven for false and misleading performance data, obscene fees, and outright crooks. What regulation are you complaining about there?