Saturday, December 5, 2009

A Reformist Manifesto

[This post originally appeared at The Epicurean Dealmaker on December 3, 2009. It is reproduced here in its entirety.]

The Communists disdain to conceal their views and aims. They openly declare that their ends can be attained only by the forcible overthrow of all existing social conditions. Let the ruling classes tremble at a Communistic revolution. The proletarians have nothing to lose but their chains. They have a world to win.

Working Men of All Countries, Unite!

— Karl Marx and Friedrich Engels, Manifesto of the Communist Party

It has not escaped my notice, O Estimable and Valued Readers, that you have displayed remarkable patience with Your Dedicated Correspondent over the last many moons of the ongoing financial crisis and its aftermath. I have ranted, I have railed, and I have hopped up and down spluttering like a one-legged kangaroo rat on a hotplate over the many failures of our present regulatory system to have avoided or even anticipated the financial tsunami which rolled over us. "Sure," I have seen you mutter to yourself, "TED has fulminated rather spectacularly about what went wrong, and how idiots, nincompoops, and boobs of every stripe screwed the pooch, but what does he suggest? Does he have any ideas, or is he merely content to take potshots at financiers, regulators, and politicians and leave it at that?"

This is a fair question, and I think you deserve an definitive answer. Being none other than who I am, however, you can rightly expect that I will give it to you with both barrels. Subtlety and nuance be damned.

I know full well what I propose is at least a bridge too far, a utopian dream doomed to ignominious death in the fetid swamp of pragmatism, special interests, and meretricious compromise which poses as our vaunted Legislative Branch. A death by a thousand cuts, each made ruefully and reluctantly by unimpeachably reasonable men and women who sport weary smiles and practiced shrugs. Men and women who explain "That's just how it is," or murmur an even simpler answer: "Politics."

But even given this—given that commentators and politicians alike have been writing fulsome obituaries for financial reform since before the first draft sprang aborning from the pen of some Congressional aide—one can still ask why should we not aspire to more? Why should we not try to map out the right answer to our problems first? The simple answer, the clear answer? Then, after we have gotten our bearings, we can debate and argue until the cows come home about the details, the practicalities, and the unintended consequences we want to forestall. Right now, all this debate—if it is taking place at all—is being conducted in the back halls, offices, and lobbies of Capitol Hill, out of public view, by the self-interested financial parties we seek to regulate and the craven legislators who hold themselves in thrall to them.

This is no way to reform our financial system, much less run a representative democracy.

* * *

So let me slap some markers on the table, in the interest of public service. These are concrete ideas which have occurred to me over the course of listening, reading, and participating in the debate over regulatory reform over the last many months. I claim no originality for these ideas, and I cheerfully admit that most if not all have already been put forth by thinkers and writers who are cleverer, better educated, and more eloquent than me. If I can claim credit for anything here, it is in laying out the best of these ideas in the most extreme form. Let us set the perimeter of the debate, and the dimensions of the playing field, before we start arguing over the color of the contending teams' jerseys.

In no particular order, here we go.

1) Ban political campaign contributions by the financial industry. We currently have the best politicians money can buy. I suspect it might be conducive toward better governance should this channel of undue influence be severed. Can you disagree?

2) Narrow and focus the role of the Federal Reserve. The Fed should continue to focus on monetary policy, price stability, and employment. It should add responsibility for monitoring, controlling, and managing systemic financial risk. Of all existing or potential regulatory entities, the Fed is best placed to do the latter. On the other hand, it has failed pathetically to protect consumers, control derivatives, or manage mortgage markets. These and any other non-core duties should be summarily stripped from it. Focus, focus, focus.

3) Render Fed actions and deliberations transparent. Secrecy runs counter to the public weal. Impose a delay of three months, six months, or whatever, but open the minutes of all material Fed actions and decisions to public scrutiny after the fact. This is called accountability, and the Fed must not be immune from it.

4) Consolidate all banking supervision under one unified national regulator. No more "regulator shopping." No more races to the bottom. Should there be real functional and regulatory differences among thrifts, savings and loans, small local and regional banks, and large money center behemoths, I am sure our clever regulators can make the distinction and set up appropriately diverse and differentiated regulatory regimes. Just do it under one roof, I beg you. I have heard no defensible reason whatsoever why this does not make sense.

5) Create a separate, independent consumer financial protection agency charged with regulating all consumer financial products and services. Regulating consumer or retail financial services is different in kind from regulating wholesale or institutional products. Among other things, consumers need protection in a way institutions do not. There is absolutely no reason why consumer protections should not be monitored by a single, dedicated regulator. If it has to do with money, and consumers, this entity should regulate it. In addition to improving the position of ordinary citizens vis á vis their financial service providers, unitary regulation of this field should encourage consumer-friendly innovation across products and services, since there will be only one regulator to deal with. The only long-term question is why this entity should not take over the consumer protection functions of the SEC when it comes to securities and markets. (My answer: it should.)

6) While we're at it, why not create a national insurance regulator? Honestly, the current state-by-state regulation of insurance companies is preposterous, and massively consumer unfriendly. At base, insurance is a very simple business, and consumer choice and value should be improved by national consolidation. Why should this be an issue of states' rights? Anyone? Anyone?

7) Create an integrated regulator of wholesale and institutional financial markets. Merge the SEC and the CFTC. Bolster its combined budget. Make broker dealers and other regulated entities provide operating funds through levies. Upgrade its systems, procedures, and personnel. Double or triple its professionals' pay, and impose a minimum five-year ban on joining any financial services provider after leaving the agency. Increase accountability, esprit de corps, and morale. Hire leaders who are dedicated to turning it into an agency everybody wants to join, instead of a laughingstock. Destroy all evidence that Christopher Cox ever darkened its doors.

8) Register and monitor hedge funds. Honestly, are we going to quibble about collecting information in this space? For what, compliance and reporting fees which will add up to less than Steve Cohen spends on Chunky Monkey ice cream every month?

9) Force virtually all over the counter derivatives onto exchanges and clearinghouses. This will increase visibility, improve netting and credit relationships, bolster systemic stability, and lower costs in most instances. (More information = lower prices.) Exceptions for highly customized OTC derivatives and/or pure end-user hedging instruments should be made on a product-by-product and case-by-case basis. If nothing else, such a regime would have enabled counterparties, regulators, and other market participants to have seen stupid, reckless, unlimited naked-put writers like AIG Financial Products coming from a mile away. How, exactly, will greater transparency and easier margin and credit control increase costs in these markets? They won't. Disagree? Prove it.

10) Simplify and rationalize Congressional oversight of financial regulators. No more oversight of financial derivatives by the Agriculture Committees, I beg you. Pretty please?

* * *

Please note that I say nothing about the particular policies which these new entities should create or enforce. Nothing about the critical issues of maximum leverage, separation of commercial, retail, and investment banking, compensation, or explicit limits on firm size or connectivity. This is intentional.

While I have some firm opinions on the right answers to many of these questions, I think it is far more important to set up strong, competent, and well-informed regulators for the financial sector than to worry about policy particulars right now. For one thing, our current regulators simply do not have enough information or understanding about the current financial system to start making those kinds of decisions. And I think most reasonable observers would agree the financial system is dynamic enough to render static regulation by explicit legislation impractical, if not downright dangerous. Set up strong regulators with clear mandates and well-defined duties, and they will come up with the right policies. What we need to do now is sever some of the improper and counterproductive patterns of influence that have hobbled regulators in the past and let the overseers of the system do their job.

Simplify, simplify, simplify. The global financial system is complicated enough as it stands. We should not render its overseers' jobs more difficult by forcing their activities into outdated, counterproductive patterns designed three quarters of a century ago for a far simpler time. Sure, many of the very same professionals and regulators who fucked up so comprehensively last time will be hired into the same roles at the same or different institutions. These brand new spanking institutions themselves will be vulnerable to the same bureaucratic sclerosis, political and ideological pressures, and civil service mentality which afflicted their predecessors. But it's time to shake things up, to clear away the underbrush, and to make a clean break with the past.

And if our elected representatives in Washington are incapable of doing this, then perhaps it is time we took to the barricades ourselves.

If I had my way
If I had my way
If I had my way
I would tear this old building down

— The Grateful Dead, Samson and Delilah

What are your thoughts, Dear Readers? I am listening.

© 2009 The Epicurean Dealmaker. All rights reserved.


  1. I am sorry to say, Sieur Dealmaker, that your scheme runs aground, as so many do, on two fatal flaws, regulatory capture and democacy.

    As soon as your regulatory agencies are founded, the call will go out for those who know the subject to staff them. At the entry level, of course, you will receive an influx of recent grads all of whom share one common characteristic: they were passed over by Goldman Sachs. At the executive level, looking as you will be for experience, you will receive a flood of applications from (a) former (and failed) employees of the industry you wish to regulate and (b) current executives within the industry you wish to regulate. In either case, a very few rounds of golf and a lunch or two (no matter who pays) with their old friends will stear you new regulatory body into a safe harbor FOR THE REGULATED COMPANIES!

    Even if you manage to stear clear of the Scylla of regulatory capture, however, your ship may well fall into the maw of the Charybdis of democracy. Staff it well with the brightest and most motivated people around, untainted by the industry you propose to regulate, and then elect another Bush and all your plans will come to naught. Refer all the cases you want to the next Albrto Gonzales and he will laugh himself incontinent as he shits all over your referrals.

    As a civil servant about to retire after many years of service under both Democratic and Republican administrations, my level of cynicism is unmatched, I am sorry to say. Much of what you say I agre with wholeheartedly, but I just cannot bring myself to believe that an effort to introduce it would work out any better than our current "efforts" in health care reform.

  2. mmm...comments!

    OK, well one obvious problem is the domestic nature of your manifesto. financial services is a international business, too much regulation in NY? go to London, or - who knows one day - to Beijing?

    (Like the Roosevelt quote)

  3. @boor and @Botogol -- Both of you convey important points. Important enough to merit their own posts in the near future. Thanks for engaging.

  4. Well said, but why restrict your #1 rule (ban campaign contribs) to financials?

    Simply: the right to vote in free and fair elections trumps the right to "speech" by non-persons. No campaign may accept any money from any non-citizen. Push me a bit harder, and I'd restrict contributions to, "citizens eligible to vote in the contested election," meaning that my Sierra Club couldn't encourage me to send money to overturn that lying scoundrel Imhoffe.

  5. Not being of the financial sector, I do not feel competent to comment on what my gut tells me is an excellent post (@boor's well-earned cynicism notwithstanding). But I guess I can make a few comments from a trust perspective.

    Most people I think would agree with the general statement that the financial sector has not behaved in a trustworthy manner in recent years. In my own work on trust, I have evolved four principles for greater organizational trust, and an "equation" for trustworthiness. A few of them, I think, help put your manifesto in perspective.

    My principles list includes consumer focus, collaboration, a long-term relational perspective (rather than transactional), and transparency. At a minimum, your numbers 3 and 9 deal with transparency; and your numbers 1, 5 and 8 deal with consumer focus.

    My equation includes credibility, reliability, intimacy and other-orientation. While these are primarily aimed at individual attributes, they have some echoes at the institutional level. In particular, the fragmented nature of existing regulation encourages high self-orientation of the players themselves, and your numbers 4, 6, 7, 8 and 10 aim at making far simpler the ability to judge for whose benefit the industry is being run.

    My models are not precisely aimed at regulation, so my effort to comment feels a bit clumsy even to me. But at a very general commonsense level, it is possible to impact trustworthiness at least in part by some structural movements. They boil down to simplifying the task of oversight, and letting some sunlight in.

    The rest has to come from within. Boor's earned scepticism is sad but clearly true; a lot of change has to come from a broader assault on what our society considers good and appropriate. MBA programs are as good a way to start as any; we need to support initiatives like the recent MBA Oath movement from students. ( After all, don't most revolutionary movements have students in the front lines?).

    Simply put, it's hard to see just what would be wrong with any of ED's proposals. From 50,000 feet, they look glaringly commonsensical.

  6. @Charlie -- Your lack of expertise in the financial sector is not a disadvantage in this instance: it is an asset. Clearly the same old thinking by the industry's members and their traditional regulators failed us, and any honest member of the financial community should welcome dialogue and fresh ideas from outside the bubble.

    Trust is absolutely key to both personal and corporate interactions, but it cannot be regulated or legislated or put in a company manual. It must be lived by each and every one of the people who wishes both to do good and to do well, whether in finance or anywhere else. You make a key point that a huge part of what makes a fair, functional, and just financial system must "come from within."

    You cannot legislate behavior or values, but unless these undergo some change as well, all the regulatory reform efforts in the world will not make a damn bit of difference.

    Thank you for your thoughts.

    For readers unfamiliar with Charlie and his extensive work and writing on trust, I strongly encourage you to visit his site at Trusted Advisor and his blog at Trust Matters. They are excellent and thought-provoking resources.

  7. Most of the points that you outline are already in place here in the UK, and were before the crisis. Yet the crisis here was just as bad, and the banks just as bust.

    The Bank of England is transparent, and focused in the way you suggest. It has no responsibility for financial regulation, only price stability and overall integrity of the system. Minutes are published, and the inflation target is public.

    The FSA is a unified national regulator of all financial products, consumer and wholesale, including both banking and insurance. It is wholly funded through levies on the industries it regulates.

    Hedge funds are required to register with the FSA, and their managers must be "fit and proper" persons, with sufficient knowledge to manage money, and no evidence of dishonesty in their background. Client monies must be handled appropriately etc.

    Oversight of regulation is in the hands of one parliamentary committee. (Albeit one with few powers)

    Additionally campaign contributions are not a huge issue here. Each of the main parties spent only £17m during the last election. (There is no political advertising on TV or radio here in the UK).

    Only two substantial elements of your manifesto that were not in place here before the crisis: A derivative exchange and separate consumer and wholesale regulators. I agree that the first is a good idea. I am unconvinced by the second, as there are substantial advantages to having a single regulator who sees the whole of a business. However I do not think this is of high significance.

    Underlying your piece is an assumption that if regulators had been properly trained, motivated, and resourced they would have put in place a structure that would have prevented the crisis.

    The problem with this view is that the orthodox theory of risk analysis used by all parties in finance was simply wrong. We believed we had a method for calculating the probability of unlikely events, when in fact this theory wildly understated tail risk. Thus bank capital, which exists precisely to absorb these events, was insufficient. (obviously this is grossly oversimplified, but the basic taleb/mandelbrot argument is at the heart of understanding what went wrong)

    No regulator is in a position to depart from standard and well recognised techniques for risk analysis. Regulators will always operate within the prevailing intellectual consensus, no matter how well trained, motivated and equipped they are. When this consensus is wrong, we cannot look to regulators to recognise it.