With stress tests completed, the administration finally seems to be edging into regulatory reform mode. On Wednesday, The Wall Street Journal reported "early" discussions on curbing pay. At the same time, Treasury Secretary Tim Geithner released a two-page memo of principles on derivatives regulation. Meanwhile, in Congress, Harvard Law professor and all-around legal polymath Cass Sunstein seems to be undergoing an easy confirmation as Obama's new "regulatory czar."
What's missing here are the details. It's no big surprise that on derivatives the White House would emphasize standardization through regulated clearinghouses and exchanges as one regulatory solution -- after all, Treasury has been urging that solution already in credit default swaps -- or that it waited until the worst of the crisis seemed to pass before seeking repeal of the deregulatory 2000 Commodity Futures Modernization Act. But as a plan, this is as sketchy as Hank Paulson's famous Troubled Asset Relief Program proposal. What agency will watch over all of this? Will we retain the absurd split between the Securities and Exchange Commission and the Commodities Future Trading Commission? Will that overseer be able to dynamically modulate capital and collateral rules, to dial back on risk in overheated markets? What will be the role of the Federal Reserve, or whatever body gets to serve as a systemic regulator, and will that regulator have oversight over other agencies? And what will have oversight over it?
In short, how will the federal government effectively balance off demands of growth and competitiveness with safety and soundness?
OK, it's early. But the real problem here is that no single detail of regulatory reform means much if we don't know the overall shape of the system. Perhaps that's coming. But it's not a particular confidence builder to dump this statement of principles on Congress, then expect the great minds there to cogitate on it and produce the all-important details. That absence of a larger vision is an invitation to ferocious lobbying and political gamesmanship, particularly since the public has about as much insight into the world of derivatives as it has into nuclear physics. (On Thursday morning, NPR still felt it has to define derivatives to its yawning, tooth brushing audience.) The issue here (and this is just the beginning) is one of complexity: despite the crisis, the more arcane a subject, the fewer voters care, the more opportunity for legislators to embrace their personal self-interest until their buttons pop. It's not a good sign when the only folks who can speak with expertise on this issue are industry reps.
Some form of derivatives regulation will come. The question is whether it will make a lick of sense. For all the warning about regulatory overreach, the real danger of both deregulation and re-regulation is partial regulation. If you need an example of a confused and fatally mixed regulatory scheme, ponder another Obama target for reform: healthcare. Like '70s stagflation, we have successfully spawned the worst of both worlds in healthcare: massive bureaucracies and regulatory agencies meet skyrocketing costs and uneven coverage. If there's one thing we've learned in the CDS story, it's that little things matter and that what seems inconsequential and esoteric, when planted in a partially deregulated environment, can explode into plagues. The fact that the Geithner derivatives plan leaves custom derivatives out may well suggest where growth will come in years ahead. And there seems to be no real plan for cross-border regulation beyond the usual nostrums about cooperation.
The banks, the firms, the funds, traders in general will always and naturally seek the unregulated piece of turf, whether it's a new instrument or a new market abroad. Opacity means profits. Innovation and globalization produce opacity. Regulatory reform, as it seems to be doing here, responds to the problems of the past, but ends up shaping the future in ways we can never fully anticipate; don't forget the lessons of the now seemingly ancient S&L crisis, which Congress tried to "fix" but only made worse. Again, we're early in what appears to be a massive effort of re-regulation, which could be the great legacy of this administration or an unholy mess. Sunstein better get some sleep. - Robert Teitelman
See pay story from The Wall Street Journal
See story about derivatives regulation from Dealscape
Robert Teitelman is the editor in chief of The Deal.
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