Regulators

You might think that an agency that missed the Madoff fraud for years even after being told about it would have some sympathy for people who are, not bad guys necessarily, just a little sloppy on the whole looking-out-for-investors front. But you would be wrong:

Securities and Exchange Commission officials are trying to make it easier on themselves to hold more individuals responsible for wrongdoing during the financial crisis.

The good news, though, is that the way they’re going to make life easier for them is by reducing the stakes, pursuing negligence cases where they only have to show that someone acted “without reasonable care, even if there was no intent to harm investors.” The tradeoff for the SEC is:
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Bear Stearns And The Criminalization of Failure

Federal prosecutors are preparing to file criminal charges against managers of two Bear Stearns hedge funds that collapsed at the dawn of the credit crisis last year. Although it’s being described as the conclusion of a year long investigation, it seems very likely that Ralph Cioffi and Matthew Tannin there wouldn’t be facing criminal charges if Bear Stearns hadn’t collapsed.
“Of course what’s really happening here is that the hedge fund managers are taking the fall for the collapse of Bear, and the even broader reverberations from that, including the controversial merger, the bailout and the credit markets’ woe,” law professor Larry Ribstein writes. “As with Enron, the public is screaming for action. When in doubt, throw somebody in jail. The public will eventually calm down, by which time the now impoverished defendants will be in jail or being exonerated on appeal.”
We wonder if the urge to prosecute doesn’t arise from an unrealistic confidence in markets. Regulators and prosecutors believe that preserving investor confidence is their mandate. Massive losses due to innocent if colossal errors about market directions undermine market confidence but there’s little a government official can do about that. If your goal is restoring investor confidence, you’re extra-motivated to find criminal wrong-doing and fraud because you can reassure investors that their losses are do to bad apples rather than risk inherent in the markets.
The Enronization of Bear [Ideoblog]

UK Regulators Still Hating On The Shorts

You’d think that if we’ve learned anything from the past few waves of financial crisis, we’d have learned that shorts sellers play an important role in financial markets.
Shorts can check otherwise unbridled financial enthusiasm, improve price discovery and have often pointed out accounting chicanery at powerful public companies. Shareholders and management are incentivized to overlook or cover-up problems. They want stocks to go up. Regulators often lack institutional incentives to investigate wrong-doing.
But shorts, like John Paulson of Paulson & Company or Jim Chanos of Kynikos Associates, can make fortunes by uncovering hidden problems. In short (sorry), they are providing the market with a valuable service–let’s call them positive externalities–all while pursuing profit.
Nonetheless, we haven’t learned this lesson at all. Today the Financial Times reported that the UK securities regulator, the FSA, is going to impose new disclosure rules on short sellers who take positions on the shares of companies undertaking new share issuances.

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If Rules Won’t Reduce Risk, Will Principles?

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

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Icahn Gets Green Light For Yahoo Stock Purchase

Carl Icahn got the go ahead from the Federal Trade Commission to scoop up huge amounts of Yahoo stock. Icahn owns around 10 million Yahoo shares now, and has options to acquire another 49 million. He said he’s seeking clearance from the FTC to buy up to $2.5 billion of the stock.
In our not-so-free market, you need the FTC’s approval to make stock purchases worth $63 million or more.
In other news, we just noticed that Jerry Yang and Steve Ballmer apparently played golf together last weekend. They may or may not have chatted about a deal but probably not the straight-up acquisition that Icahn wants. Icahn, of course, hates executives who play golf. Is there any chance that Ballmer and Yang arranged the meeting over golf to piss off Icahn?
Icahn gets antitrust go-ahead for Yahoo stock buy [Yahoo–heh]

California Backs Off Hedge Fund Regulation Plan

Opponents of hedge fund regulation scored a win yesterday when California backed away from its plans to regulate hedge funds. Since the registration of hedge funds with the Securities and Exchange Commission was over-turned by the federal courts, several states have considered enacting their own regulatory schemes. Such moves have typically been opposed by the hedge fund industry, which has recently become active in federal and state lobbying efforts.
“California withdrew its proposal this month after many hedge fund industry officials suggested the lightly regulated investment funds could move to another state if California started regulating them,” DealBook reported this morning.
California is thought to have the largest concentration of hedge funds outside of New York, Connecticut and the Dallas area. California’s high-concentration of wealth and agreeable climate make the state very attractive to fund managers. But faced with the threat of extensive regulation, many could choose to relocate to states less prone to regulation.
“Yes, and they would take with them all those huge houses, big cars and taxes paid by hedge fund managers,” law professor Larry Ribstein explains. “California is used to having its regulatory way because many firms can’t avoid its market. But hedge funds can operate just fine without California.”
California’s surrender on hedge fund regulation nicely illustrates how federalism forces states to compete with each other, and can check excessive regulation. This is sometimes decried by critics of federalism as a “race to the bottom” but there’s little evidence to suggest that states are forced to lower regulatory levels on investment managers to below optimum levels. If investors desired more hedge fund regulation, hedge funds would have financial incentives to locate in states with greater regulations. Hedge fund investors, however, seem to doubt that they would benefit from new regulations that go beyond traditional legal strictures against things like theft and fraud.
California Drops Hedge Fund Proposal [DealBook]
Hedge funds and jurisdictional competition [Ideoblog]

Comcast Packed The Net Neutrality Debate At Harvard

Napping For Comcast.jpg
Yesterday a cameraman for the Free Press caught two members of the audience napping during an FCC hearing on net neutrality at Harvard Law School. Now we don’t blame them for snoozing through a meeting about net neutrality–our eyes glaze over just thinking about it–but it does raise the question: why would you go to an FCC hearing if you are bored by that type of thing?
Portfolio’s Sam Gustin has answered the question: they were there because cable giant Comcast paid them to be there. Comcast had planned to pack the meeting with its local employees, and had paid some people off the street to show-up early and hold places in the line for the employees.
“Some of those placeholders, however, did more than wait in line: they filled many of the seats at the meeting, according to eyewitnesses,” Gustin reports. “As a result, scores of Comcast critics and other members of the public were denied entry because the room filled up well before the beginning of the hearing.”
Money can’t buy you love, but it can buy you napping bodies to keep your critics at bay.
Comcast Astroturfs the Old-Fashioned Way [Portfolio.com]

  • 04 Feb 2008 at 3:20 PM
  • politics

The Psychology Of Overregulation

We’ve been on a bit of a tear today about the politics of regulation. So why quit when we’re having so much fun with it? As we noted today, calls for additional regulation often depend on a double standard under which market process are characterized by imperfect information and dominated by self-interest while regulatory processes are somehow viewed as well-informed and public-minded. Why are people so attracted to regulatory solutions when despite the lack of evidence for concrete benefits?
David Hirshleifer has a delightful paper that sees through one prominent anti-market double standard and suggests an answer—several in fact—about why regulation is unduly attractive. His approach is simple. He points out that the findings of behavioral psychology—that people are often irrational, biased and ill-informed—apply to regulators as well as investors and consumers.
“The psychological attraction theory of regulation holds that regulation is the result of psychological biases on the part of political participants and regulators, and the evolution of regulatory ideologies that exploit these biases,” he writes.
The cumulative effect of these biases is overregulation. “[Since the universe of possible tempting regulations is unlimited, the theory predicts a general tendency for overregulation, and for rules to accrete over time like barnacles, impeding economic progress. The theory also predicts occasional drastic increases in regulation in response to market downturns or disruption.”
You can download the paper here. (Hat tip to Ribstein.)