Thursday, October 23, 2008

Chris Cox Hopes to Fail Upward

If you are a loser, sometimes your best strategy is to do something insanely stupid, so off-the chart stupid, that it mandates new charts of stupidity must be made. Thus, otherwise forgettable figures like David Chapman or traders like Nick Leeson have Wikipedia entries, while their betters are assigned to ignominy; they win! Perhaps that was Chris Cox's savvy strategy all along. He screwed up in various ways (short sale prohibitions), plus missing out on making good changes that seem, with hindsight to be sure, should have been made.

Thus, it is fun to see Chris Cox, head of the SEC, whose job it is require what kind of information public companies to disclose got to say his piece in front of the current Congressional hearings. After allowing complex financial companies to basically put up opaque financial statements, and by their accomodation give the impression everything is fine, Cox notes in this insightful (though horribly depressing to any rationalist) Congressional hearing:
what happened in the mortgage meltdown and the ensuing credit crisis demonstrates that where SEC regulation is strong and backed by statute, it is effective

Just like the DC school, I'm sure more money, as opposed to different priorities or management, would help ;).
challenge its reliance on the Basel standards and the Federal Reserve's 10% well-capitalized test
OK, if the capitalization standards were much higher, say 15%, what would have been different?
credit default swaps ensured that when the housing market collapsed the effects would be felt throughout the financial system.
So, blame the messenger, not the message. Cox harps on this a lot, as if the 'unregulated' credit default swaps, which are derivatives, are the basis for the fact that mortgages issued in 2006 had twice the loss rates as previous mortgages. If mortgages weren't worth 10 cents on the dollar, there would be no problem. The ABX.HE (subprime CDS) market highlighted that prior to any other indicator--way before the rating agencies. If anything, this diversified the risk, as opposed to aggrevated it.
So, bottom line for Cox, head of the SEC,
Today’s balkanized regulatory system undermines the objectives of getting results and ensuring accountability.
In other words, double his budget, increase his power, and all will be well.

Then, when asked if the best they can do, is be, like Greenspan says, be right 60% of the time. Is the best we can expect, a regulation that has a 40% chance of being wrong? Cox replies:
That's a bit more quantitative than I have an ability to evaluate is time to have a process that gets rid of regulatory gaps.
So, in other words, I don't know about 'numbers' or 'estimates', even as vague as what Greenspan mentions, but more power for the SEC is still an obvious solution.

Comically, Waxman laments that the current regulatory agencies all missed the boat, implying giving them more authority would be rather pointless (Waxman is a typical Democrat, so that's funny). What to do? Ack!

Regulations are necessary. That they be wise is very important, so the focus should not be the 'more' or 'less' debate, rather than the what (because the general debate is not soluble in finite time). Let's focus on what those might be, rather than giving blanket powers, especially to agencies that have demonstrated a lack of any efficacy in the past (SEC, OFHEO).

The crisis reveals that the stupidity that creates crisis is far deficient to the stupidity of those who rush in to assign blame and design cures. President Obama's first task should be to fire all the senior people (eg, Cox) at all the regulatory agencies, to set the tone that it will not be tolerated that regulators fail: failure has consequences. They should know that if their companies screw up, they screw up. They can not blame the companies they regulate, they are responsible for the companies they regulate. That is, the first new regulator power, should be to highlight to these bureaucrates


paul said...

this is why Fischer Black is God

Hedging, Speculation, and Systemic Risk

Fischer Black
Sloan School of Management, MIT


Investors like to speculate. Financial institutions accommodate them, often hedging to reduce the risk of insolvency. Neither investors nor financial institutions create systemic risk. Governments do that, by refusing to enforce contracts, and by guaranteeing private debt without charging market rates for the insurance they are providing. Then governments ask for tax money so they can regulate to reduce the systemic risk they themselves have caused.

Anonymous said...

interest rate setting by central banks should be prohibited. these fuckers created the mess. japan, swiss and the fed. decentralize and let the market work itself up. otherwise this will never be solved. they can put layers of regulators to no avail.

AHWest said...

Get rid of the moral hazard and then let the market genuinely work at preventing systemic risk.

A regulator facing bigger downside just won't allow the subjects of his regulation to take any risks at all. It's like the FDA - no regulator will ever get fired over a potentially life-saving drug that never comes to market due to risk averse regulators. It will forever remain out of sight, murdered in the crib.