Monday, December 13, 2010

Regulators All Talk

The problem when someone is given authority to regulate something really complicated, where the agents under regulation have vastly more knowledge of the product landscape than they do, is that the regulators know they don't know what they are talking about. For all Warren has studied credit cards and mortgages, I bet she still doesn't know what the expected charge-off rate is on 550-600 FICO credit cards off the top of her head. The participants know this stuff inside and out.

Thus if they create a stupid law making X illegal, all the industry does is create a slight modification and generates the same result, or a different industry takes up the slack with more onerous terms. Worse, like the Carter credit controls (which caused a GDP tailspin in 1980:Q2), it can totally shut down a market, highlighting their ham-handedness. Thus, regulators rarely do anything that might have a conspicuous effect (eg, they passed a health care overhaul that will be rolled out in such a fashion people will never agree as to the effects)

Smarmy Warren's initial big idea was to simplify and standardize contracts. Thus, instead of having a mortgage contract with tens of pages in 10-point font, requiring 10+ initialings, you have one page with simple terms a regular person can understand. Unfortunately, simplification comes with a cost. It groups many contingencies under one big tent, and so specifics can not be spelled out. When someone gets screwed by some specific clause and did not foresee it, they have historically argued to courts this was unfair, which created the lengthy documentation. The many pages and initials are meant to capture these cases, and now must be inferred.

So, pick your poison: a simple general statement that hopes people can figure out the special cases, or list all the special cases, making the general statement more obscure. I'm all for standardization, but the banks will reasonably demand indemnification for such simplicity, and the Trial Lawyers will fight it. She's going to be shocked when her push-back comes from her side of the aisle.

In the meantime, the new agency is guaranteed funding from the Federal Reserve, so it will be part of the government forever. Its main objectives are enumerated thusly:

  1. Research
  2. Community Affairs
  3. Complaint Tracking and Collection
  4. Office of Fair Lending and Equal Opportunity - ensuring equitable access to credit
  5. Office of Financial Literacy - promoting financial literacy among consumers

These objectives are covered independently by tens if not hundreds of other agencies that produce lots of stuff no one cares about. Highlighting the regulators continued cluelessness, they raise the 'equal access to credit' as a right as opposed to the signature problem that led to the mortgage bubble. Discriminating on ability and/or willingness to pay invariably hits certain demographics differently, so this is a classic efficiency/equity trade-off, and we know where the government stands. The implications, however, are not obvious, as many still think this had absolutely nothing to do with the mortgage meltdown.

I'm sure Warren is happy as a pig in poop creating her new fiefdom with all the status it implies. As the first director, surely several conference rooms, pavilions, if not entire building will have her name on them after she leaves. As to actually helping the consumer, say by proposing specific data that would increase transparency, that would take greater understanding of the product landscape than she and her ilk have. For example, why not make it easy for investors to see the track record of investment advisers and hedge funds? Currently, getting that data is not merely difficult, but often illegal! How about making it easier to see who has sued whom and for what? If someone has sued several prior colleagues and a neighbor, that's darn useful information, but currently it is made very difficult to acquire. Why not take over the rating agencies production of 'default studies' with your own, independent validation, so that we can see how AAA and BB ratings do for various categories without the tendentious reporting?

Instead they will busy themselves having meetings, creating task-forces, showing they listen, and maybe some pointless regulations that merely add fixed costs to the business (eg, the Security Exchange Acts of 1934 and 40 are good examples).

Here's the UN Global Climate committe describing their latest meeting
The United Nations Climate Change Conference took place in Cancun, Mexico, from 29 November to 10 December 2010. It encompassed the sixteenth Conference of the Parties (COP) and the sixth Conference of the Parties serving as the Meeting of the Parties to the Kyoto Protocol (CMP), as well as the thirty-third sessions of both the Subsidiary Body for Implementation (SBI) and the Subsidiary Body for Scientific and Technological Advice (SBSTA), and the fifteenth session of the AWG-KP and thirteenth session of the AWG-LCA.

This blurb underneath a picture of them all applauding themselves! How wonderful that they all care enough to make time for Cancun in December to talk about global warming.

What has come from all these meetings? Well, they all agree that 'something should be done', and voted for the rich countries to give money to the more numerous poor countries. Needless to say, this has no impact on anything, because bureaucrats can't unilaterally budget such expenditures. That's top-down politics. To think that Hollywood created a big production to pass the law creating Warren's CFPA, highlights how many people get excited about government power, when really all they mean is more government expenditure and sinecures.


Carsten Valgreen said...

Hi Eric,

Thanks as always for a thoughtprovoking blog. Enjoy your utterings, and generally agree with you. As a continental European it strikes me that some of the problems in the US mortgage space are refelcting the more general problem of common law: That contracts have to cover just about everything than can happen on earth. Sometimes standardization of contracts in the form of law as happens in the continental European form leads to much smaller and clearer contracts, less litigation .. and not to forget less lawyers. That might sometimes be economically efficient too.

Anonymous said...

Enjoy your blog, less so the gratuitous ad hominem attacks ("smarmy Warren"??)and dismissive condescension. (Has anyone pointed out that the tone of your blog is often indistinguishable from that of Austism's GadFly?)
Shame that the chip on your shoulder is detracting from your keen intellect.


Eric Falkenstein said...

Anon: I think Warren's a simple muck-raker for appealing victims, and her academic studies are so filled with omitted variables biases her work fills a much needed gap. Now, I may be wrong, but if I believe that to be the case, my condescension is simple honesty. If she isn't smarmy, the word has no meaning.

J said...

How could be "pointless" to spend a few days in Cancun in December? Michigan weather is better?

Anonymous #5 said...

If one starts with the assumption that all government regulation is either completely ineffectual or counterproductive, then it's quite hard to avoid the conclusion that government regulation is worse than useless.

But your post is quite long for the reiteration of a single assumption, combined with resentment-generating storytelling details ("smarmy", "conference rooms", "picture of them congratulating themselves", "Cancun in December") that you would probably consider irrelevant if they were being applied to executives at a large bank.

If there was some government regulation that had prevented your former employer from fucking with your livelihood, would that be a good thing? Or is such a regulation inherently impossible, or would it as a matter of logic create side effects worse than what actually happened?

Anonymous said...

"gratuitous ad hominem attacks ("smarmy Warren"??)"

Should Eric refrain from using adjectives and adverbs? Or perhaps use them only when describing inanimate objects?... He's an opinionated essayist, and his color is useful to the reader. When I read his characterization of her as "smarmy," I thought: yes, that's the word I was looking for!

Dave said...


If you were in charge of creating a new regulatory structure for the financial industry from scratch, what would you do?

Eric Falkenstein said...

I'd focus on disclosure, providing information. As mentioned, return data, default data, at the level of actual funds and products. Legal data are very difficult to get. When I head head of Risk capital allocations at KeyCorp, I could tell you how we sliced risk for every line of business, with numbers. The fed should discuss these in detail, and show by comparison which firms are leading and which are lagging, what data they look at. Those not tracking things like LTV should be exposed.

Anonymous said...

Hi, i just want to say hello to the community

Unknown said...

Mr Falkenstein,
Did you leave the fund management business to become a risk software consultant or programmer?
Thank you for your reply.

Eric Falkenstein said...

I'm a quant at a firm that engages in many things...I work at a 'software' company for regulatory reasons. I do not discuss what I work on, but I can say it is high frequency and equity related.

Anonymous said...

You are being tough on Warren... she is a lawyer... did the general counsel at Key know the default rates for various credit buckets?

Anonymous said...

If the general counsel at Key was setting credit policy, as Warren is, he or she should have known the default rates per bucket.

I think you give Ms. Warren too much credit, though. I think she knows the default rates per credit bucket and either doesn't care or refuses to believe them.