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Saturday, January 28, 2012

A Future of Regulators at Fault?

The typical case in the U.S. is that the industry being regulated resists being regulated, while the regulators insist on enforcing the regulations. To be sure, particularly strong firms in an industry may propose incremental regulations for strategic advantage—knowing that smaller or less profitable firms in the industry would have more trouble complying financially. The strategic use of regulation is an under-appreciated phenomenon in the de-regulation movement. Perhaps even more bizarre is the case of an industry complaining about lax enforcement of existing regulations and demanding even more. What industry might fit this bill? As a hint, look for a major scandal that did reputational harm to an industry.

In the industry, the firms’ calls for a crackdown must contend with a legacy of a light regulatory touch.” People in the industry question whether regulators have been “too gentle” on the firms. If a firm “runs afoul of the rules, regulators largely rely on the firms to report their own wrongdoing.” It sounds like Andy Taylor’s jail in Mayberry—the keys are hanging on the wall, help yourself Otis (he was the drunk). From 1996-2011, regulators penalized only ten firms, letting scores of others off the hook “because [the] regulators deemed their violations accidental.” The sounds like the work of Andy’s deputy, Barney—find the loot only to lose the criminal.

I am describing the futures industry, whose firms, “ordinarily loath to accept regulation,” decided in the wake of MF Global’s collapse and loss of $1.2 billion of customer money to spearhead efforts for “new oversight as they try to heal the black eye.” In its article, the New York Times describes the existing regulations as nearly non-existent. For example, “firms need not inform customers of the whereabouts of their money.” It is no wonder that prospective customers would be hesitant to enter that arena—hence the firms’ financial interest in additional regulations. The question is perhaps why the regulators had not recommended any to Congress.

Without the usual vested interests thwarting prospective regulations bearing on themselves while Congress stands by and takes the contributions, any additional regulations “spearheaded” by the industry can be expected to be enacted. The question, I suppose, is whether the regulators will feel like enforcing them. With no headwind from the industry, lax enforcement would be an interesting nut to crack. Could it be that regulators exist who don’t believe regulations are very important? Such a mentality would be the opposite of public service—something like agnosticism in religion, only as held by clerics. Such a thing simply is not expected, hence it is worth investigating.

The most likely explanation is that the regulatory agency was “captured” by its industry, and ultimately it was in the interest of the industry itself to come up with something stronger. If so, might it be that once the new regulations are up and running, particular firms or the industry as a whole might want to capture the agency again? Even in following the industry’s “spearheading,” the agency is essentially “captured.” Is it the case in the American system more generally, that agencies are captured by their regulatees whether in increasing or decreasing enforcement? In other words, might the business and financial sectors be too powerful over government for their own good—like children telling their parents when to discipline them and when to let them get away with something?  The sectors—and in particular their largest firms—may be too powerful for a viable republic: TBTG, meaning too big to govern. TBTF might not be the biggest elephant in the living room after all.

Ben Protess and Azam Ahmed, “Insiders Call For Oversight of Futures,” The New York Times, January 26, 2012. http://dealbook.nytimes.com/2012/01/25/futures-industry-sees-chance-to-shape-oversight/