Why Financial Regulation is Doomed to Fail

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D. Saul Weiner's picture

This is a very good article, a technical topic explained in layman's terms.

It is unfortunate, though not surprising, that this type of analysis was not considered when Congress deliberated for the latest round of so-called financial regulation legislation.

This analysis reinforces for me that regulation is really a form of central planning, so we should not be surprised when it fails to produce the stated objectives, or in fact works counter to them.

A Liberal in Lakeview's picture

Wow. The section, "The Goldilocks of Risk", was eyepopping. Too bad the gladhanders and grandstanders, i.e. politicians and their hangers-on, are visionary planners of society with little interest in slowing down long enough to understand the research. Also illuminating was the influence of BIS and the Basel Accords on American banks. A few observations about Maymin's essay:

(1) Maymin wrote that the Basel Committee on Banking Supervision publishes "suggested bank guidelines", but later he added that under the Basel Accord's guidelines, "the bank that wishes to own $100 million of IBM stock may not unilaterally decide how much or how little risk capital to allocate for that ownership; it must conform to the regulatory requirements." So are they guidelines that obligate no one or are they requirements to which bankers must conform?

Perhaps the trick to understanding the guildlines of the BIS and BCBS is that that they are analogous to recommendations published by the NCCUSL. If so, the BIS and BCBS would rely upon its members' several legislatures, e.g. Congress, to implement proposals, just as the NCCUSL doesn't publish laws but recommendations that may be codified by the legislatures of the provinces that Americans call states.

(2) At the end Maymin claims that "[w]e have over 150,000 pages of federal regulations for various industries". I can't help wondering how he came up with that number. That would be 300 volumes with 500 pages per volume. So, is he counting both Statutes at Large and the United States Code? If so, then he must be double counting regulations. Another complication when trying to cite a neat and tidy number for the quantity of regulations is the set of many rules issued by various federal agencies.

To paint a more precise picture, Maymin should cite one compilation or the other or both separately. Of course, if leftist bloggers and journalists investigate his claim and find it misleading, then Maymin will have discredited his own cause in proportion to the error, and it would hardly matter if the total number of pages turned out to be more than 150k. The goo-goos would probably trivialize that fact or neglect it altogether. In the meantime, some libertarian or conservative parrot will repeat the number 150k without doing the least bit of research to check it out. The claim could take on a life of its own, like some feminists' perennial shrill cry that women are paid just n% of what men earn, where n is always a good deal less than 100.

(3) Maymin asked rhetorically, "[h]ow do banks work today?". His answer: "Basically, they hold leveraged portfolios of assets and decide how much risk capital to allocate to be able to keep holding those positions during times of distress." (Emphasis added.)

If that's "basically" what he's teaching his students about banking, his students ought to plug their ears during class, for Maymin has a very superficial understanding. Keep in mind that "risk capital" is not a synonym for reserves. I suspect that his students' interests would be better served by not taking his class(es) at all, thereby saving several thousand dollars of tuition.

Instead, they ought to burrow their way through Rothbard's A History of Money and Banking in the United States, which they can download for free. They could supplement their study with Modern Money Mechanics, first published by the FRB of Chicago in the 1960s and revised numerous times since then. It explains, among other things, the basics of deposit expansion and contraction under the system of fractional reserve banking established by Congress. This work, too, they can get for free. And of course, Mayim would have more time for statistics-driven research, which he seems to be good at.

(4) If there were a free market in banking, then there'd be no banking cartels set up by government, no central banking, no sheltering of bankers from the vice of fractional reserve warehouse banking, and so on. Undoubtedly the bankers won't like this definition. Neither would the leftists.

(5) Maymin wrote that "...no algorithm for calculating the required risk capital for given portfolios results in lower systemic risk"? C'mon, now, that doesn't even come close to passing the smell test. A cluster of warehouse banks each operating at or near 100% reserves would surely have low systemic risk. Of course, their dependency upon each other would be low, each bank would have few investments, and the regulators would have abandoned their old preoccupation, namely, meddling in banking in order to stimulate loans and investments by bankers.

(6) The usual suspects will clamor for Mayim's "hypothetical regulatory agency", even though all experience shows that it's going to be a gigantic failure. The superagency toward which the world is heading will provide job opportunities for many law school grads and econ professors. And can you imagine the anxiety attacks of partners in big law firms if all those regulations were swept off the books without delay? What would they tell associates who've been racking up 2,000 to 3,000 billable hours per year in order to become partner and to enjoy the perks of crime that's organized under the color of law and protected by $45k/yr cops with degrees in criminal justice?

Yes, regulation is like central planning; it amounts to politicians and bureaucrats exercising dominion over matter, physical stuff, that is nominally the property of others, i.e. business owners. Of course, even b-school books inform their readers that one of the purposes of regulation is to thwart competition. So business owners may not have the justification for complaint that at first appears to be the case.

Anyhowm, why don't we claim that regulation is a little like Fascism, supposedly the merger of the corporation and the state? Regulation, you see, is the merger of corporate management with the state.