Will the Administration’s Regulatory Overhaul Work?


broken Wall Street sign; via iStockphoto.com

Question: How serious is the administration about true reform of the financial system? Are its plans likely to work?

Or is regulation a can of worms, a Pandora’s box, and every other cliche that might be subsumed under the Law of Unintended Consequences?

Paul Solman: First and easiest, the administration seems deadly serious. So does Federal Reserve Chairman Bernanke.

As to workability, well, the issues are numerous. But kind of interesting.

Consider the front men for the reforms, Larry Summers and Tim Geithner, who previewed their reformist ambitions in a Washington Post op ed Monday.

First and foremost, the knocks on Summers/Geithner:

1) They’re too cozy with, and therefore too sympathetic to, Wall Street;

2) Their careers have displayed something less than the financial probity you might expect from “reformers.” (For Geithner’s tax problems, see here. For Summers’ main issue, see David Warsh’s latest, though there’s also the matter of his millions in income from a hedge fund while teaching at Harvard.)

A counter to (1) is that, in the taunting words of my youth, “it takes one to know one.” When FDR put rum-runner Joseph Kennedy in charge of the SEC in the 1930s, for example, it was considered a stroke of regulatory genius: the fox in charge of the fox-house. Who better to rein in the renegades of finance than those who know the tricks of the trade?

Another defense: Summers, and Geithner especially — a lifelong civil servant — sure could have made a lot more money GOING to Wall Street than hobnobbing there.

But I’m asking me, not conducting a NewsHour debate here. And me, myself, and I all worry more broadly than about the sins of Summers and Geithner (though we confess: “worry” is our default).

My main worry about regulatory reform of the U.S. financial system is so broad you might call it global — inter-galactic even: Does Wall St. do a creditable job of performing its main function, its raison d’etre: to channel money from the world’s investors to its most productive uses?

The more intimately I’ve come to know the system over many years (I originally typed “tears”), the more reason I’ve had to distrust it — and to think the answer is “no.”

And yet: compared to what? Wall Street’s abuses are legion and, like the poor, always with us, as even the most cursory reading of the history of finance makes clear. But can the system be reformed by those outside it? Can the foxes be outfoxed?

At this Olympian level, I can’t really improve, I don’t think, on what I wrote here last month.

Personally, however, I’m more concerned that Wall St. will stay ahead of any regulation, however well intentioned and well crafted. I once talked to a guy about a story that I never wound up doing. It had to do with a maneuver in which shares of stock were converted into debt, which was then tax deductible. I wondered aloud if this was good for America.

“Hey look,” the guy said to me, “if you’ve got a problem with that, just end the tax deductibility of interest.”

“Oh yeah,” I scoffed. “That’s real easy to do!”

“It would be if you gave the job to me and six of my smartest guys. We’ll write the law in a few months.”

And then followed an exchange I’ve never forgotten.

“When you go back into private practice,” I said, “could you beat the law that you’d written?” His answer?

“I should certainly hope so.”

That said, regulation is an absolute necessity, in markets as in all human environments. It’s an eternal cat-and-mouse game. The regulators are usually playing catch-up. But if you simply stop playing, watch out.

But let’s get our feet back down on the ground to assess what the administration is actually proposing.

First, “transparency.” A good thing in the eyes of any reporter. Many people were bilked in recent years, borrowers and investors alike, by the arcana of finance. Demystification, outside the theatre, is almost always a good thing. On the other hand, if there is to be little or no punishment for those who engaged in mystification for the purposes of fraud in recent years, how chastened is Wall Street likely to be going forward? How likely to come clean, demystify, become usefully transparent?

Next, increased capital and margin requirements: New regulation will require financial firms to put more of their own money down when they buy. Again, a good thing, for the rather obvious reason that the LESS of your own money you put at risk when making an investment, the less careful you’re likely to be — AND, the more vulnerable to steep downturns. Ask any gambler playing on credit.

And yet, no regulation — no matter how well-intentioned — is either air-tight or cost-free. Compliance costs. Unexpected consequences cost. (Just look at something as recent as Tuesday’s Wall St. Journal for a story of well-intentioned Medicare cost-saving rules gone awry.)

Two last concerns.

One: The efficacy of regulation comes more from the efficacy of those who administer it than the regulations themselves. It’s not that we didn’t have an SEC or Federal Reserve all these years. It’s that those running the SEC and the Fed devoutly believed in Wall Street’s ability to regulate itself. As, it seems, did Larry Summers.

Two: The biggest problem of all seems to have been how many financial institutions turned out to be “too big to fail.” If they’re not cut down to size, then, are the new reforms failing to address the underlying problem of our times?