Financial Regulation

Regulatory Reform - An Update and Assessment

With Congress in summer recess it is an appropriate time to assess what has happened in this once in a lifetime opportunity to reform financial regulation. It is enticing to say not much and end this note now, but I can’t resist the opportunity to bore you a bit with my review of recent events and a cautionary note as we go forward.

In reality not much has been accomplished in terms of actual reform although there continue to be a substantial number of proposals on the table including the Administration’s proposal, which is comprehensive in approach. Congress has institutionalized bank compensation reviews and oversight although it is unclear precisely how this will work and what in fact it will accomplish. Also stockholders will now be given the right to vote on compensation packages for key executives, although such votes are non-binding. There must be some logic to that little piece of meaningless reform, but I am hard pressed to tell you what it is.

The more substantial proposals have gotten bottled up for several different reasons. My award for the most colorful moment in a not particularly colorful process was when the heads of the major regulatory agencies brought their turf war to a Congressional hearing. It was reported that the generally unflappable Secretary of the Treasury was less than subtle in voicing his dissatisfaction to the aforementioned group after that fiasco. Can’t say I blame him although it is a bit unusual for an Administration official to address the heads of supposedly independent regulatory agencies in such a way.

This lack of tangible accomplishments doesn’t mean the game is over. When Congress returns financial industry regulatory reform is likely to get attention assuming health care insurance doesn’t become completely overwhelming. What I find concerning at this stage is the likelihood of compromise resulting in costly regulation with inadequate attendant benefits to justify the changes. We have had a hint of that already. The SEC seems serious about adding to the industry data collection burden by requiring that information on activity in over the counter derivatives be provided periodically. This information will then be made public, but only in aggregated form and with a one-month lag. I suppose in about 10 years that may generate sufficient data points to support the empirical part of a Ph.D. dissertation, but I cannot understand what else will come of this additional collection burden. Will SEC staff be examining this data as it comes in and if so what will they be looking for? How will what they be looking for differ from what the examiners have on their list? You get the point. Financial institutions will be adding to their costs with no apparent associated benefits.

The aspect of regulation that seems to get little to no attention is that compliance is not free; in fact it can be very expensive. IT costs can escalate quickly when firms have to reengineer processes to effectively comply. Obviously there is no increase in revenue associated with these regulatory activities. That puts pressure on banks to find sources of additional revenue to counter these added costs. A particularly appealing source is fees. The high visibility recent changes in credit card terms are at least in part a response to an increase in the cost of doing business. (The other part is the curtailment of profitable, albeit risky activities, either because of regulation and/or management response to large losses.) There are other knock on effects that are worthy of further discussion, perhaps in a future note. For now we can agree that when bank costs are increased by added regulation and compliance, at least some of those costs are likely to be passed on to the banks’ customers. My cautionary note is that regulators should take these costs into consideration when reforming regulation to ensure that what we are paying for is worth the price.

Ben Wolkowitz Headstrong August 25, 2009