Ask leading questions much?
The answer to your question is: No.
I’m happy to expand on that. Laissez-faire regulation on both sides of the
Atlantic has clearly failed. I’m trying to understand why and think about
how to fix things.
Here in the U.S. the Reaganite experiment of financial deregulation reached
its apogee roughly in the 2004 to 2006 period. That wasn’t supposed to
happen. The pendulum was supposed to swing back to a more regulation in the
aftermath of the stock market bubble, the accounting fraud pandemic and the
Wall Street research scandals. Yet after SOX was passed and the
Spitzer-inspired reforms, The Wall Street Journal edit page and the US
Chamber of Commerce et al spent years railing about the regulatory
overreach. Sarbanes-Oxley purportedly was having malign effects on American
competitiveness and New York was threatened by London and Hong Kong. We were
strangling technological innovation. The reality is that we were blowing
another bubble, while the SEC and the Fed shirked their regulatory duties. I
have no doubt that a concerted regulatory effort starting around 2004 or
2005 to regulate mortgage lending and to examine leverage in the system
would have helped enormously, had the regulators been given the mandate. But
the Bush-era SEC and a Greenspan-led Federal Reserve had no interest.
One point about London, which I think is underappreciated in the States, is
that they were running an even purer laissez-faire financial experiment. I
was puzzled how that happened, but the reason turns out to be fairly
obvious: The FSA, the British super-regulator, was created when the
financial services industry was strong. And the British economy is even more
dependent on the financial services sector than the U.S.
What’s interesting is that even though we have two different structures and
two different approaches, we both got into very similar problems. We have a
deeply overleveraged financial system and a bursting housing bubble.
To go to your question, I’ll concede that the words "structure" and
"approach" are doing a lot of work in those sentences that you quoted from
my column. By "structure," I am referring to the super-regulator structure
of the FSA, with its wide-ranging jurisdiction. By "approach," I’m referring
to the laissez faire hands-off nature of the FSA, versus the enforcement
orientation of the SEC. The FSA prefers to have open dialogue and
historically the SEC — much less so under the Bush/Cox regime — was more
aggressive. File the "principle-based" vs. "rules-based" debate under
"approach."
To answer your question: I think "principle"-based regulation is pretty much
a crock. But it’s beside the point. The "principle" approach is a euphemism
for being hands-off. As you see from my column, the FSA has virtually no
enforcement staff or budget. So the British regulators couldn’t enforce
principles if they wanted to.
I think we should stick to rules. Principles are what firms need to adhere
to themselves, by creating internal cultures that respect the rules, the
regulator, and their customers.
For instance, some firms have in-house risk management departments that are
the "risk police" and some have risk management sitting at the table as a
partner. At the Risk Police firms, you push deals you can get away with.
That’s bad for the firms and bad for the markets. Our regulators could try
to find ways to encourage the creation of internal cultures that reward high
principles as well..
Regulators need to enforce the rules. This is the problem. It’s been
exacerbated by our ridiculously Byzantine regulatory structure. It’s obvious
to most people that we need a radical overhaul of our regulatory structure,
but if it’s not back by a regulatory attitude change then it will be for
naught.
Here’s where I would start: The US needs a significant amount of regulatory
consolidation, and I think the FSA is a decent enough starting point. We
need to wipe out the CFTC and combine it with the SEC. We don’t need myriad
bank regulators or state insurance regulation, so let’s consolidate those.
We need to bring derivatives and most off-exchange contracts under the SEC
umbrella explicitly. And just maybe our elders were onto something with
Glass-Steagall and we should consider bringing it back. I can’t see how that
would work, to be honest.
In addition, I like the idea that the FSA, rather than the Bank of England,
has regulatory authority over banks. I’m inclined to think that monetary
policy is a hard enough job without having to think about bank regulation
too. But I’m open to hearing opposing views on whether the Federal Reserve
here should be stripped of its banking regulatory authority. At a minimum,
we should have a radical consolidation of our bank regulators, as I say. And
if we keep the current system, investment banks should — and will be, I
expect — brought under the Fed’s jurisdiction. Then we need to have
regulators much more focused on leverage and capital requirements.
But the main point of the column is that regulators have to regulate. We
need to bring back regulation’s good name. Everything follows from that, um,
principle.
In my October column for the magazine, I’m going to propose a non-regulatory
fix that we need in addition. Stay tuned!
