Platt Perspective on Business and Technology

Considering a cost-benefits analysis of economic regulatory rules – 12

Posted in in the News, macroeconomics, outsourcing and globalization by Timothy Platt on June 16, 2012

This is twelfth installment in a series on the cost-benefits analysis of economic regulatory rules (see Macroeconomics and Business, postings 64 and scattered following for Parts 1-11.) And I have to admit this is currently so fast-changing a topic area that while I started out with historical narratives, I have found myself writing about current news and events too. And I continue that pattern here with this installment.

At the end of Part 11 I stated that I was going to add a posting, discussing “the impact of marketplace regulatory control and its successes and failures as they reach beyond the marketplace per se.” I went on to say that I would focus at least as a starting point for that on the issues of wealth and opportunity distribution within and across societies and the impact of skewed wealth distribution on societal stability, and on how the debate over regulatory control can, in practice, hinge on this set of issues. I will do that in this series installment, looking at the way that wealth distribution in the United States has shifted in recent years, bringing about an inequality of distribution of a degree that we have only experienced in this country in times of overall financial disturbance and instability – and notably, most recently reaching current levels of unevenness of wealth distribution in the years immediately leading up to the Great Depression of 1929 and the 1930’s.

The specific measure I would use and cite for this type of analysis is a mathematical economic tool: the Gini coefficient as it comparatively measures income distributions across members of a society’s overall workforce. Gini coefficient values can range from zero to one, with a zero indicating absolute equality of income distribution across a workforce and for all working members, and a value of one indicating as an alternative extreme that all income goes to just one workforce participant with everyone else receiving nothing for their efforts. And right now, as indicated above, labor statistics indicate the United States is operating economically at a higher Gini coefficient value than it has at any time since the 1920’s (see US Department of Labor, Bureau of Labor Statistics, statistics on pay and benefits.

So this assessment is not simply a matter of vague or general opinion, but rather is grounded in solid empirical data, as analyzed using standard mathematical techniques. And in this, I would argue that both the United States manifestation of the Occupy Movement as started with Occupy Wall Street on the Left, and the Tea Party movement on the Right in the United States, and their ascension into sociopolitical prominence of attention and concern fit a pattern that has shown at other times and in other places when the empirically measured Gini coefficient for a society has drifted into so skewed a position. One message that both of these movements have come to hold in common is that of inequality in voice and in opportunity. And bringing this into tight focus, much of the Occupy Movement rhetoric concerns the top 1% wealthiest and the remaining 99% who are argued to be left out.

And with that, I bring the issues of regulatory control and oversight into this discussion, and the often bitterly contested disagreements as to what is necessary – or simply questionable and wrong. And in that context I note the two basic perspectives that have come to dominate this debate as to regulatory control and oversight per se.

• One perspective would view regulatory control and oversight as primarily serving to preferentially limit marketplace access and opportunity to compete – and opportunity to generate and accumulate wealth through imposition of unnecessary and artificial barriers.
• The competing vision and perspective holds that regulatory control and oversight, at least when effectively drafted, primarily serves to level the playing field (e.g. so all participants: businesses, consumers and investors face equal opportunity and risk as I would formulate this perspective.)

And that brings me to a news story that is both current and unfolding for its details as I write this. And I begin with a system of derivatives trades that went bad for JPMorgan Chase and its CEO Jamie Dimon.

JPMorgan Chase managed to avoid much of the losses that so many other large banks and investment firms fell into from toxic investments made leading into the Great Recession. One consequence of that was that Jamie Dimon became a leading spokesperson in the fight against regulatory control and oversight that was being proposed and pushed forward – specifically to limit exposure to the risk inherent to the types of trades that proved so toxic going into the Great Recession. I refer here to hedge trading based on opaque and high risk investment instruments such as complex derivatives. Dimon argued against regulatory control in general and against imposition of a strong Volker Rule in particular, arguing that it was unfair to in effect punish “good banks” for the action of “bad banks.” He argued that if a general regulatory framework was imposed at all, it should be weak, so as to not limit the prudent investment practices of good banks in a rapidly evolving marketplace. And then JPMorgan Chase found itself publically facing the same type of investment practice scandal that had rocked the financial industry in general, leading us all into the Great Recession.

The investment failures and resulting losses that broke this news story began in London with what was initially called a local failure of due diligence and risk management oversight. And this was all blamed on the reportedly rogue actions of one trader – building up a combined loss of some $2 billion for the bank practically overnight. This, Dimon acknowledged, damaged his credibility as he argued against the Volker Rule leading up to the date at which it would first formally go into effect, this coming July 21, 2012. Then it turned out that this one incident was in fact not so much an anomaly within JPMorgan Chase and its system of investment practices. This was more a point of failure emerging from more standard and ongoing high risk investment practices that were being followed there, and identified as their risk hedging investment practices. And it was found that this red-flag of a failed investment decision was not going to be limited to just $2 billion and even just in immediate loss. As of this writing, on March 18 (I am close to a month ahead in preparing my postings), it has been announced that immediate loss from this will reach and top $3 billion – and there is speculation that overall losses from this will come to total over $5 billion. And I find myself coming back to thoughts of the Gini coefficient and the drive towards ever more inflated and hyper-inflated personal compensation among the senior executives of these institutions – and of the increasing dissociation between who faces potential gain and who faces potential risk from even the highest risk investments (see my series Stockholder Meetings, Annual Board Meetings and Annual Meetings Best Practices in my Guide to Effective Job Search and Career Development – 2 for background information on executive compensation practices, and earlier postings to this series for information on risk/benefits distribution.)

I have been weaving a complex story here with several distinct threads, but they do all come together.

• Those who argue and push back against regulatory control, come to take that position for a wide variety of reasons but for many if not most, their reasons come down to a single shared point – the way in which regulatory control and oversight can be seen as limiting opportunity to accumulate and concentrate wealth, and personal wealth.
• From a personal wealth perspective and as a matter of risk and benefits a practice that increases personal exposure to likely benefits while reducing exposure to concomitant risks is always going to be favored. But those concomitant risks will not simply go away. They can only be redistributed, and for high risk investment practices that means placing them on the shoulders of other stakeholders and participants.
• When this is done and on a large and systematic scale, the overall consequence is to both increase likelihood of adverse impact on the economy as a whole, from scale of overall economic transactions caught up in this investment behavior – and this can and will also shift overall income distribution, driving an increase in the value of the Gini coefficient.
• And when this value increases sufficiently, a correlated increase in sociopolitical instability develops too, as increasing numbers impacted by the downside of these investments react and act out, individually or through grass roots organizations such as the Occupy Movement and Tea Party activism.

I have, up to now, taken a primarily pro-regulatory control position in this series, and for a simple reason. I have focused on the development and imposition of effective regulatory control and oversight. I am going to switch directions in my next series installment and will discuss good and bad regulatory mechanisms and law, and some basic criteria that go into identifying a proposed regulatory process as one or the other. Meanwhile, you can find this and related postings at Macroeconomics and Business and also at Outsourcing and Globalization. See also Ubiquitous Computing and Communications – everywhere all the time.

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