Give the regulators some love

| February 14, 2012 | 0 Comments

Today is Valentine’s Day. Even if you had all intention of ignoring this holiday, you can’t. Especially if you’ve turned on your TV in the past few days. Many companies have been shamelessly trying to convince us that spending beaucoups dollars is the only way to show our love.

The nerve. Except — sometimes money is the only way to show your love.

Rare is the person for whom money is no object. This is especially so for recent college grads who’ve got debts to pay and adult lives to establish. Many therefore take the highest-paying careers that they can find (while still staying on the right side of the law.) Nowadays many are compelled to take any job they can find. Is it any wonder, then, that we’ve lost some of our brightest minds to finance?

A good example is Vikram Pandit, the CEO of Citigroup. He used to be an electrical engineer. But it’s not just in the C-suites: risk management, ALM, FX teams, rate desks — Wall Street is filled brilliant people who all chose financial security above all. So what about the folks who are supposed to shield us from the worst excesses of these hired guns?

Just consider the Commodities and Futures Trading Commission, which looks after MF Global and the like. They’re babysitting a $600 $300 trillion market but have only been given $205 million with which to do it. How many physics PhDs are going to want to play in that kind of ballpark?

Money’s not love…except when it is. And if we want to regulators who are the cream of the crop, then we’d better learn how to make them feel all warm and tingly inside.

This was the winning argument in a recent contest of the International Center for Financial Regulation and the Financial Times to find the best ideas on the future of regulation. Connel Fullenkamp, an economics professor from Duke, and Sunil Sharma, the director of the IMF-Singapore Regional Training Institute, suggest a model to help regulators even the arms race.

Fullenkamp and Sharma propose a novel idea: that regulatory agencies be given enough funds to hire enough bright people to actually do the job. That this is seen as a radical concept is cause for concern.

On an institutional basis, Fullenkamp and Sharma propose something similar to the way in which gasoline taxes are used to fund road maintenance. A small percentage of bank assets, just 0.2%, could be set aside to create a fund to do this. In 2010 bank assets averaged $63.1 trillion, meaning that $12.6 billion would have been raised in that year. The authors say that this is more than double what federal regulators, excluding the Federal Reserve, are currently allocated. Their fund sounds very similar to the tax that’s being mooted in Europe. Except that Nicholas Sarkozy and its other proponents would prefer that the cash went straight to their national budgets. (London, on the other hand, will hear none of it.)

Now many will say that the government and its agencies are the very last place to whom one should give $12.6 billion dollars. It’s not exactly known for its good housekeeping of late. Fullenkamp and Sharma agree that regulators in such an automatic funding arrangement might become “complacent or  unresponsive to the needs of society. Legislative oversight may [also] be ineffective for political reasons or due to industry capture.” Therefore they also propose a sort of independent audit system to keep the regulators honest: ”The appraisal, and the agency’s response, would become public documents and help in the oversight of the organization.”

In theory, perhaps. The Government Accountability Office is very close to this at the moment, and their performance tends to the wan side. I don’t think slaps on the wrist help at this level — what they’d somehow need to have is the power to hire and fire.

As for directly incentivizing regulators with a fat paycheck, the authors remind us that

[m]any of the schemes now being considered in the private sector, such as deferred compensation and claw back arrangements, were initially proposed for regulators in the aftermath of the U.S. Savings and Loan Crisis.

So why not steal a page back out of the banks’ playbook? Fullenkamp and Sharma say that regulators should get bonuses, but would be forced to invest some of it into a sort of insurance fund for banks. If the banks ever need saving, then part of their bonus will go up in smoke. Join hands, brothers, we’re in it together.

But why stop there? The authors suggest that we could go even further and require that regulators actually own stock and bonds issued by the financial institutions that they regulate. (Congress already does it, so why not? Unlike Congress, however, we would have to insist that the regulators use a blind fund.)

Note that Goldman Sachs’ risk managers, considered the best on the Street, are paid like and given a status that’s close to the traders that they corral. So why shouldn’t we be more like the squid and show our regulators that this relationship is actually going somewhere? You never know where it might lead.

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Image credit: valordictus on Flickr

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Category: Regulation