Platt Perspective on Business and Technology

Considering a cost-benefits analysis of economic regulatory rules – 7

Posted in macroeconomics, outsourcing and globalization by Timothy Platt on May 2, 2012

This is my seventh installment in a series on the cost-benefits analysis of economic regulatory rules (see Macroeconomics and Business, postings 64, 66, 69, 70, 72 and 74 for parts 1-6.) I have, up to now, been developing a line of argument in this series that regulatory law and its effectiveness needs to be more thoroughly and effectively analyzed according to its costs and benefits. I have further argued that the key to any such analysis is not so much in determining the absolute levels of cost and benefit that would be expected, and even when these are determined on s statistical likelihood and risk/benefits basis. This analysis also has to focus on where among involved stakeholders, these risks and benefits are distributed. And for stably effective sustainable regulatory guidelines and law these systems of oversight have to enforce proper behavior by increasing returns to stakeholders where a specific set of principles are adhered to (as first listed in Part 1 of this series.)

• The absolute levels of potential risk and benefit are not as important as the symmetrical distribution of risk and benefit as shared – ideally, at least, equally by all involved stakeholders.
• And the real risk of instability and crisis comes from risk and benefits distribution asymmetry.

I specifically focused on these market stability parameters in Part 6 as a matter of operational principle, and stated at the end of that installment that I would turn to the issues of implementation here. And that is the goal of this posting, to propose some specific details that would have to go into any regulatory law that would follow this approach.

I want to start this discussion by listing four specific operational regulatory goals, each of which I would claim to be essential for moving forward, if we are to step out of the pattern of recurring growth, bubbles, collapse and disruption, retrenching and at enormous and asymmetrically distributed cost, regrowth, next-cycle bubbles and so on.

1. End golden parachutes as we have known them with failure of oversight responsibility requirements spelled out in detail and with failure in meeting those requirements serving as grounds for voiding these executive employment contracts. The goal of this point is to structurally enforce self-interest driven oversight from within lending and corporate investing organizations and from their executive suites on down. And legal precedent for this level of executive responsibility as to fiscal soundness can already be found in laws such as the United States Sarbanes-Oxley Act of 2002.
2. Make loan officers and their managers responsible for the consequences of failing to observe a set of minimum due diligence standards that would be mandated by regulatory law – and with the specific goal of redistributing the risk so as to make it more equitable.
3. And establish a new and even legally mandated class of insurance coverage to cover for the impact of misfeasance and malfeasance in practices followed. For a perhaps parallel systems example, medical doctors who serve on hospital staffs can still be sued for malpractice and even when they are working as employees of those institutions and under their umbrella malpractice insurance coverage; I propose here allowance for a counterpart to medical malpractice insurance with insurance companies involved allowed to set their premium rates on the basis of their reviews and analysis of the overall risk levels that come into play from loan agreement practices in place, and on the basis of the track record for risk issues for the brokers and their companies seeking this coverage.
4. Enact a US Food and Drug Administration (FDA)-like governmentally managed organization for investment instruments that operates and rates the stability and effectiveness of investment instruments according to a published, consistent, transparent set of risk/benefits distribution criteria, and that scores investments along a quality scale that matches the ratings systems used for institutions, as for example by Moody’s or Standard and Poor’s – thus creating a more information-rich marketplace for the investment consumer, and whether individual or institutional. Here, I note that failures leading up to our recent and still resolving Great Recession stem in significant part and certainly for their severity from a lack of independence of those and other publically held ratings agencies from the organizations that they were supposedly impartially evaluating. Or alternatively and with threat of enacting this type of governmental oversight, formally and specifically establish a legally defined firewall separating private ratings agencies from the businesses and organizations that they would rate. In practice, a combination approach might be both more effective and more politically feasible to enact and enforce.

These only lightly touch upon a few possible details that I could cite here, and that I am sure most readers could think of too. But however a next generation regulatory framework would be developed in detail, if it is to be sustainable long-term it has to build from a foundation of the two top risk/benefits distribution bullet points. As long as their distribution is allowed to drift into a position of significant skew, it will do so and that will always lead both to dilution of regulatory control and that next cyclically recurring systematic financial meltdown and failure.

And I end this posting going back to an Irving Fisher quote that I cited in Part 1 of this series, spoken and written on the eve of the Great Depression:

• “Stock prices have reached what looks like a permanently high plateau.”

Even the best and the most long-term sustainable regulatory frameworks can only do so much towards preventing fiscal systems instabilities and even cyclically recurring ones. So the goal here is not so much perfect as it is better, and even much better as a stretch goal. Stretching out the cycles, and reducing the heights and the depths of the unsustainable growth and collapses we recurringly see would be a tremendous improvement and on any time scale, and ultimately for everyone.

I have been posting this series up to here entirely in terms of United States law and the US marketplace and economy. I am going to turn in my next installment to at least begin a discussion of these issues as they play out in a more global framework. Meanwhile, you can find this and related postings at Macroeconomics and Business and also at Outsourcing and Globalization.

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