Fed Conference in Hotlanta: Part 2 – Sweating the Details on Regulatory Efficiency

Continuing my previous thoughts on last week’s Atlanta Federal Reserve Financial Markets Conference, I thought I’d cover another of the conference’s big themes: the efficiency of the regulatory system.

Two things matter to a well-functioning regulatory system: the complexity in the regulation and the political system that backs up that regulation. Political systems matter because of the potential influence on a majority party. Democracies where one party cannot easily take control (political economists call them “liberal democracies”) are least likely to have banking crises.  This is because liberal democracies such as Canada and New Zealand are less likely to have one party in the majority, one party whose special interests form the regulation of the banking system.

Complexity also matters. In mathematics, short, elegant equations with a lot of explanatory power are seen as the ultimate goal. According to the Bank of England’s Andrew Haldane, complexity means burdensome compliance costs and more room for companies to find loopholes; complexity favors larger companies who can afford the big law departments that are needed for compliance. Now think of the Dodd-Frank Act. It’s huge! Dodd-Frank is over 800 pages, compared to Glass-Steagall Act’s relatively diminutive 37 pages.

It’s not clear to me how to solve the complexity problem in the U.S.  Our lawmakers glean input from lots of special interests – big banks, hedge funds, small businesses, and consumer advocacy groups. All those groups all have competing interests, so that resulting regulation develops facets for each of them, resulting in more and more complexity. That’s something likely not to go away any time soon. Maybe another source of this complexity is the default position of regulation based on the negative – “you can’t do this and you can’t do that.” Regulation based on proscription almost has to be complex to include the myriad of possible ways of circumventing regulation. A little prescriptive regulation might help – regulation that spells out only the things a firm is allowed to do. It’s got to be far easier to spell out three things that are allowed, rather than the 300 things that aren’t.

During the conference, Atlanta Fed Governor Lockhart called the meeting a mid-point check-up on the reforms made since 2008.  However, it should be no surprise, given the complexity of the U.S financial system and its regulations (seriously, over 800 pages?) that the big take-away from this conference was that more work needs to done. Of course, the next crisis may not look like the last, but it’ll probably have several of the same characters.

 

 

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