In a hilariously naïve opinion piece called Over-regulated America, the February 18, 2012 edition of The Economist makes “a plea for simplicity” to replace what it characterizes as the U.S.’s overly regulated financial system. In place of Sarbanes-Oxley and Dodd-Frank, it proposes that regulations not contain specific rules but rather merely “lay down broad goals” and “leave the regulators to enforce them.”
This is the so-called “principles-based regulation” that they have in Europe – the envy of the world when it comes to banking. America should return to its European roots, The Economist is saying. After all, the U.S. is “the home of laissez-faire.” (You would think the editors could have sent a fact-checker through the Chunnel to the Bibliothèque de la Sorbonne, but the point is not lost for the error). According to The Economist, there is nothing wrong with the American banking system that a big dose of European regulation won’t cure.
So instead of having a regulations manual that says, for instance, banks cannot engage in specified levels of leverage in proprietary trading, The Economist thinks it would be good enough to have a regulation that says to banks: “don’t put your capital at risk.” Although we tried that already, let’s humor (or humour) The Economist and pretend we haven’t. What would that be like?
First, it would concentrate the power to make specific rules in lower-level bureaucrats. Somebody has to put meat on these bare bones. Recognizing this problem, The Economist counters that “unreasonable judgments should be subject to swift appeal” and “regulators who make bad decisions should be easily sackable.”
Once you think about this process (and if you hurry you can still beat The Economist‘s editors in doing that) you will easily understand that the principles-based solution is more complex than the current one and would prove even more costly to implement. Instead of hiring lawyers to read and help banks interpret specific regulations, the banks would hire lawyers to advise them whether a certain plan of action would violate the broader, “don’t be risky” dictum. Then the lawyers present their case to a bureaucrat, who decides the issue: in this particular case, under these circumstances, it was or was not too risky to use this much leverage.
Appeals to the courts ensue. God help the lower bureaucrat who made the first decision; he will be “sacked” if it was a bad one. Sounds like a great job for which truly qualified applicants will undoubtedly be lining (I’m sorry, “queuing”) up.
While that case is being decided, hundreds of others are running their course through the bureaucracy and the courts. These fifty situations are too risky, these fifty are not. A “body of law” is developed. Lawyers write law review articles with titles like, The Seventeen-Factor Test for Determining Whether Your Planned Leveraged Trading Strategy Violates The Volcker Principle. If you think Occupy Wall Street is an impressive encampment, wait until you see the lawyers’ bivouac outside the U. S. Court of Appeals for the District of Columbia Circuit.
What you end up with, after several years of this torture, is a rulebook with all of the same details and burdens The Economist claims to find distasteful. You can call this process lots of things, but laissez faire ce n’est pas. The same result could have been achieved less expensively and more efficiently had rules simply been laid down in the first place by those with the expertise to adopt them.
According to The Economist, Americans “love to laugh at ridiculous regulations” like the one that required those kids in Bethesda, Maryland to get a permit for their lemonade stand. But it turns out that the story of the lemonade stand, like most real-life examples put to use by those with an agenda, has two sides. Those kids wanted to sell lemonade during the U.S. Open golf tournament on a busy thoroughfare near the golf course called Persimmon Tree Road. The “regulators,” i.e. policemen responsible for the safety of the children, motorists, and pedestrians, didn’t shut the kids down, nor did they fine their parents, as was widely misreported. Instead, they simply made them move around the corner to a less busy street.
The Economist would probably point out, in its typically myopic fashion, that the move was bad for the lemonade business. But even under its proposed regime, regulators could have written a general rule that prohibits vending in unsafe situations, instead of a specific one that prohibits kids from selling lemonade by the side of Persimmon Tree Road during the U.S. Open. Few Americans, however, would share The Economist‘s view that it should take a tragic accident to prove those two rules are one and the same.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds and issuers of securities, among others. Our regulatory practice group assists financial service providers with the complex issues that arise in the course of their businesses, including compliance with federal and state laws and rules.