Tuesday, September 11, 2012

The Smartest Paper Ever From a Regulator

In case you missed it, Andrew Haldane's "The Dog and the Frisbee," the paper he recently presented at Jackson Hole, was brilliant.

According to the understated prose of the Bank of England, the paper by the Bank of England's head of financial stability "explores why the type of complex financial regulation developed over recent decades may be sub-optimal for crisis control."

In other words, fighting complexity with complexity is a prescription for failure. The financial system has evolved into mind-numbing complexity, partly in attempts to creatively evade letter-of-the-law regulatory regimes.

Regulators will always be outgunned, if they choose to do battle on this field. The banks have the intellectual firepower, the sheer manpower, the profit incentives -- basically, everything in their favor -- to keep running circles around hapless regulatory officials.

So Haldane (my bold):
...calls for a fresh approach to financial supervision, one which is less rules-focused and more judgment-based. He notes that this approach: “...will underpin the Bank of England’s new supervisory model when it assumes prudential regulatory responsibilities next year.” To be effective, he says that will require more experienced regulators working to a smaller, less detailed rulebook. He adds that greater simplicity and consistency in disclosure practices could also strengthen market discipline.
As I wrote on this blog three years ago (arguing for a new philosophy of regulation based more on principles than on a myriad of rules purporting to cover every relevant situation):
One problem right now is that we lay out rules, in staggering detail, and anything not prohibited is generally assumed to be legal. That invites the creation of a loophole-seeking culture in the financial system.
I don't think the U.S. has any visionaries of Haldane caliber in the upper ranks of its regulatory bodies. Maybe the best we can hope for is that if England develops a regulatory system that's smarter, better -- and simpler -- we might have someone bright enough in our country to realize that, and copy the best parts of it.

P.S. For evidence of the complexity rampant in the financial system, that exists only to arbitrage regulations, check out SunTrust’s postpaid bifurcated collateralized variable share forward on its stake in Coca-Cola in this wonderfully titled Dealbreaker piece, "Spoilsport Regulators Ruin Another Derivative That Was Too Beautiful to Live."

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