Transactions: June 22, 2009

Democracy is buying, not renting. The renter may feel responsibility for his abode, but ultimately it belongs to someone else. Why shampoo the rug? Many have observed this throughout history: Life under a despot may be miserable, deadening, radically unsatisfying, but there's a fugitive freedom lurking within: You don't have to feel responsible for the goose-stepping idiots in charge. A buyer, however, is stuck with the joint; he's the idiot in charge. He can blame the neighbors, shoddy construction, a termite conspiracy, but if the house starts to collapse, it's his problem. Unless he can unload it, he can't escape some measure of responsibility. On the other hand, he can do nearly anything he wants to the joint -- in real life, within limits, but this is a theoretical democracy, a hypothetical house and a tortured metaphor.

Today's subject is regulatory reform. First thought: We're messy, aren't we? Second thought: What else is new? Consider how our ideal despot would proceed with reform. There would be no lobbying, no jibberjabbering, no turf protecting. The despot simply draws up the most rational plan available -- one banking regulator, one systemic regulator, powers of seizure, experts in derivatives, consumer products, capital markets. The bureaucracy rises like a well-made chest of drawers. Regulators could be opaque; regulatees would be transparent. Regulators would ensure that our needs, defined by said despot, are met. Executive comp? Hammer it down everywhere. Too big to fail? Break the big banks up. Too much leverage? Enforce universal capital requirements. Too little savings? Ban SUVs, private planes, cigarette boats. Too much risk? Reinstitute full personal liability and debtors' prisons. Moral hazard? Let markets wreak their vengeance. Regulatory capture? In the event of a screwup, kill the regulators.

Of course, that's not the way we do it. First, people want their stuff; even if they lack a cigarette boat, they can aspire to own one. Why own a house if you can't park a boat in the driveway? Second, folks want a modicum of what risk provides: credit, leverage, liquidity. What that modicum should be remains open for debate. Third, post-crisis, the peeps don't care about regulatory arcana. Result: Every regulator gets to defend traditional prerogatives by ginning up support from corporate constituents -- evidence of the ineradicability of regulatory capture -- and pledging allegiance to jabberwocking pols. Part of this great democratic tradition, which began about three minutes after George Washington was inaugurated, features feverish lobbying by all interests: big banks and small, exchanges and clearinghouses, institutions and retail, investors and dealers. This lobbying lollapalooza even occasionally works, which is why folks feel compelled to do it; if you don't do it, the next guy may eat your ham-on-rye. The tendency here (beside the instinct that bureaucracies naturally seek growth) is always toward fragmentation, enlivened by knife fights.

This does not paint a pretty picture. But it explains a lot about the nature of regulation itself, not in some airy-fairy despotism, but in a bona fide democracy. Take the banks. Bankers ritually decry the Balkanized regulatory thicket they're stuck in. But because there's so much of it -- and even in the deregulatory glory days, rules were so voluminous no one was ever in perfect compliance -- banks felt compelled to lobby for their own regs and regulators (more evidence of regulatory capture). This creates greater fragmentation and more rules, which in turn spurs more lobbying. Fragmentation and complexity spawn hidey-holes to make money, which eventually triggers a crisis, which fuels another paroxysm of rulemaking, institutional reshuffling, lobbying. There appears no end to this. Once a crisis abates, pressure to change anything but your underwear recedes. In short, the appearance of health creates preconditions for disease. This could be the definition of banking.

This is the price we pay for democracy. Democracies are inherently optimistic because, what the hell, it's our crib and we're into self-expression. Besides, the belief that we can design a perfect system to ensure this never happens again is as utopian as the schemes of our insane despot. Perhaps the best thing to be said about hypothetical plans tossed out by Treasury is that we know full well they aren't perfect; in fact, they're so deeply flawed that for now at least we may handle risk as if it's nitroglycerin. But that will pass. There is a sort of rough-and-ready relation in a democracy and a market system between the depth of a crisis and the duration of our memories of it. This resembles the tradeoff between risk management and risk: The more we trust the former, the more of the latter we pile up, ending up in roughly the same bad place at roughly the same time. The Great Depression was so ugly it took 40 years to forget its lessons. We're more advanced. We'll forget it all in six months.