Details of regulatory overhaul are finally public

Whew! OK, so my very first blog post last fall I said that the regulatory structure of the United States needed a big overhaul. And lo nearly 8 months later details of such a plan have finally been made public. Before talking about the details, President Barack Obama sums up the need for these regulations very succinctly:

“Millions of Americans who have worked hard and behaved responsibly have seen their life dreams eroded by the irresponsibility of others and by the failure of their government to provide adequate oversight. Our entire economy has been undermined by that failure.”

Let’s look at the details, shall we? Just after I will provide a little commentary.

• Consumers would be offered more “plain vanilla” financial products.

Commentary: One of the reasons for the massive financial industry meltdown is that very sophisticated financial products were being offered to consumers in an effort to get a low current monthly payment for borrowers. As we all know by now, many levers were manipulated to make this possible. Each lever that was pulled was a variable in a sophisticated mathematical options model. As long as the models’ inputs created profitable outputs then banks would lend money. The colossal clusterfuck was that it was assumed that these models mirrored a particular economic environment: rising home prices and tons of money in the system (i.e. liquidity). When those things turned out not to be true….well you know the rest. So this simple adjustment above is for the benefit of consumers. But also note the stark way that it hampers lenders. If products have to be “plain vanilla” then it takes all of the sophisticated math of the investment bank out of the equation. This means that consumers will actually be able to shop mortgages better as they will actually know what the hell they are buying. I guarantee you that the financial community will argue that this will ultimately raise borrowing costs for consumers. My rebuttal is, maybe in the short-run, but in the long-run there will be fewer defaults and no recessions that border on depressions due to a bunch of wonks not getting their mathematical models correct. Duh! Make me a promise ye loyal blog readers, that you will remember this point as these reforms are debated into the future. Will you do it? Thanks.

• A new agency will be created to regulate consumer financial products.

Commentary: Amen! We have friggin‘ regulation of toys that shoot little plastic missiles that could kill 2 babies per year (an acknowledged sad outcome), but no regulator that oversees most people’s single largest purchase in their lifetimes, a house? That is screwed up. Or their second largest purchase? A car. That is screwed up. It’s not that it is the “wild west” out there. There is oversight, but the oversight is not clearly the responsibility of any one person. Pay close attention to the TEETH granted this regulator; it will be these teeth that serve as a check on the Ivy League preppy frat boys that run most banks and investment banks.

• The Federal Government would have expanded powers to take over failing, massive financial institutions. They would also be able to oversee firms that could pose a threat to economic stability even if they were not specifically a financial firm (read: the auto industry).

Commentary: Hmmm. I have to confess that I am not a big fan of this detail. I think that capitalism works best with clearly defined rules that create an even playing field between buyers and sellers, but once that is established, then capital should accrue to great businesses and it should drain away from bad businesses. This means that big institutions can and will fail. The distortions are created when in the back of an executive’s mind is a thought like: “I normally wouldn’t take such a dumb assed risk, but I know that the taxpayer will bail me out.” Unfortunately, going back to Ronald Reagan’s bailout of Chrysler in the 1980s we have 2 generations worth of executives who know that if they are too big too fail, that they are just that. So I am against this little proviso. I do agree with Republicans that governments do not do a good job of micro-managing specific businesses.

• Executive compensation would face more scrutiny.

Commentary: Hallelujah. The primary faults with executive compensation are: that the giagundo amounts of potential reward create such tremendous incentives to lie, cheat, steal, beg, borrow and gamble your way to possible success; and that executives receive only reward for the risks they take, no losses. Let me further explicate this last point. As a stock investor, what happens if you fail to properly assess the risks in a business? You lose money. As a real estate investor, what happens if you fail to properly assess the quality of the home you buy? You lose money. What happens as a high level executive if you fail to properly assess the risks of a massive business decision? You might get fired and when you do, you get a giant severance package that is guaranteed. Where is the risk of personal financial loss? A suggestion for improving executive compensation is to keep an account of an executive’s compensation awards. Any gains based on her or his decisions are credited to the account. Any losses based on his or her decisions are debited from the account. This account is locked up for 10 years, even if the employee retires.

• Hedge funds will face more scrutiny.

Commentary: Regulatory transparency is absolutely essential for regulators to do their jobs. Hedge funds and their byzantine noodlings are currently invisible to regulators. Back in the day when the percentage of hedge monies invested relative to all investment monies invested was minuscule, regulating this niche was not crucial. However, now hedge funds are a vital part of the functioning of financial markets nationally, and internationally. With that responsibility comes…(this is shocking folks)…responsibility. Duh!

Hedge funds claim that the secret to their success is proprietary investment strategies and that somehow the success of these strategies will be crimped by a regulator seeing and more importantly, knowing how they operate. There is another group of market players that also make money based on proprietary secrets and secret products that hates official oversight: the Mafia. I really see only fine distinctions between the worst hedge fund outlaws and the mafia. Sorry, I call it like I see it. I managed a mutual fund for a number of years and did just fine having very high regulatory scrutiny and having to disclose my holdings every 6 months and did just fine. And hedge fund guys are much smarter than I am. So regarding increased regulatory scrutiny: so be it. Three times in my investment career hedge funds and hedge trading, in general, have nearly collapsed the U.S. economy. Whatever happened to “three strikes and you’re out” as applied to white collar sheisters? There is more regulatory scrutiny of boxing than hedge funds.

• Miscellaneous adjustments to regulatory structure would streamline bank regulation and banks would be required to hold more capital on hand.

Commentary: The details of these are likely to be adjusted so commentary here is not particularly useful.

*****

Ultimately there are no surprises in the official release of proposed regulatory change. The details have been leaked and discussed publicly and privately for months. As consumers and investors it is essential that we pay attention to this piece of legislation. It is one of the most important for the future economic health of the nation in our lifetimes. And I am no exaggerator.

Thanks for reading!

Jason