Complexity
March 21st, 2008 by Peter SudermanOver at the Atlantic, Megan McArdle predicts that more regulation is certainly in store for the financial sector — but isn’t sure it’ll do much good:
[T]he broad demands for “stricter scrutiny” and “more transparency” are meaningless…
The problem is not transparency but complexity: The value of the securities was as opaque to those who held them as it was to everyone else. Regulating away the risk of a repeat will involve doing away with much of the complexity that has broadened and deepened US capital markets over the last thirty years. This may be necessary. But one thought should give pause: Many of these complex securities were created to get around previous regulations.
This seems about right to me. Legislators tend to think that they can do away with behavior they don’t like (in whatever realm) by prohibiting certain actions and methods. But even when the regulation is generally successful at enforcement, such behavior typically manages to find other outlets in which to act out. The trick, usually, is to avoid trying to squash it and instead look for ways to better incorporate it into the system.
March 21st, 2008 at 1:25 pm
Although perhaps if we were to find ways to prevent their lobbyists from writing the regulations, this wouldn’t be quite a concern. What’s needed, and Chris has been pretty good about saying this, is a coherent regulatory philosophy that can guide us through these kinds of crises.
March 26th, 2008 at 6:53 pm
I agree with that, but it’s a difficult thing to do with these credit default swaps, since they’re not traded openly and their value is very difficult to determine (these are the things really screwing up the economy right now, too). When major bond insurers are claiming they were duped by the big financial companies about the value of these credit swaps, you know we have a real problem here. How do you “incorporate it into the system” without some kind of regulation (open trading of the swaps, for example)?