Top 5 Problems Facing the Economy 3

This is part 3 in a series of 5 posts all part of the same headline, “Top 5 Problems Facing the Economy.”  I feel that the number 3 problem facing the economy is the lack of financial market transparency.

Given the first two problems, lack of ethics in society – especially in business, and chronic fat – that is, consuming beyond our means, it is very important that there be a proper regulatory framework in place to provide ground rules for the operation of the economy.

I have likened poor economic laws and regulations to poor rules in American football, roll them back, or take them away, and in several seasons you would have a blood thirsty melee.  Why?  Certain elements are in place in football that are similar to the economy: intense competition, large interest on the part of the public, and very high financial stakes.

Think about it.  Why do businesses always want a roll back on regulations?  The reason given is always that there is intense global competition and that unless regulations are rolled back those businesses will move their operations and their jobs elsewhere because of the very high financial stakes.  This outcry usually attracts large interest on the part of the public.

Unfortunately, because there is no set of comprehensive and uniform set of international business laws or regulations, countries and international businesses act in cahoots with one another to create loose laws and regulations in order to placate businesses.  Governments want the jobs for their citizens and the tax revenues for their coffers.

Yet, the job of government is not just financial.  One of the reasons that governments exist is to take care of those things where there isn’t much of a financial interest on the part of business.  These non-financial, yet essential functions, are usually referred to as externalities – because concern for these things is external to the economy.  Military, police, road building and maintenance, utilities, maintaining voting systems, and funding courts are large functions of government.

But guess what else is, too?  Maintaining a set of laws and regulations that provide a safer and more defined culture are, too.  Yes, many laws and regulations have a negative affect on the economy, but many of them also have different goals.  Think about air travel security.  It is a complete and utter drag to the economy to have you take off your shoes, take out your lap top, and be hand scanned by the TSA.  I am certain that millions and millions of hours of economic productivity has been lost to the security check in at airports.  But do we really want to live in a world where the most expeditious form of travel is unsafe?  No.

Hopefully I have established the need for laws and regulation under certain circumstances.  So admitting that laws and regulations are necessary then means that the law and regulators need transparency in order to function best.  I said in an earlier edition in this series that there are three major concentrations of power in most countries: government, military and business.  Checks and balances exist between these sources.  One of the checks of government on too much business power is: laws and regulation.  For government to do its job necessitates the ability to know what is going on.

Yet, especially in the financial world and in the economy, regulators have been intentionally underfunded and intentionally hamstrung by the very governments that created them.  For example, the Securities and Exchange Commission (SEC) is chronically underfunded by Congress.  Another example, the global value of financial derivatives is nearly ten times the size of the annual economic output of the entire world – yet, almost none of the details of that market can be seen by regulators!!!!!

What regulators need to know is who is party to the transactions so that they can examine the intertwining and compounding of risks in the global financial system.  Even if they had the legal right to transparency, they then would also need to be funded properly so that they could do their jobs well.

Another example of a lack of transparency is the opaque quality of the hedge fund industry.  This entire industry exists because the various Great Depression era acts that regulate the financial industry exclude rules for QIBs.  What the heck is that?  Qualified Institution Buyers.  The assumption is that if you have either financial industry experience, or a net worth over $1 million then you don’t need the protection of the financial industry’s watchdogs.  This is an absurdity.

What has happened is that institutional investors, hedge funds, have used sophisticated methods to increase the leverage on returns for their funds, as well as the risks to themselves, their investors and to the entire global financial system.  Additionally, they use sophisticated quantitative methods, such as super computers, to execute extraordinarily rapid and high volumes of financial market trades.  The problem is that if there is a mistake – as there was with the “flash crash” of 2010 – then the cost to investors globally is in the billions of dollars.  How many other errors are made that go unnoticed because the monetary value of the mistake is seemingly inconsequential?

So you have a very small regulatory benefit handed out to a very small, yet growing, group of investors, but because of the amounts of money involved, have a huge affect on the financial markets for everyone.  Yet, there is no regulatory oversight.  Tell me that’s not a problem for the economy.

I could go on, but a simple analogy will close my argument: watch dogs, of hen houses or financial markets, need to know what is going on in order to do their jobs.  That requires transparency and resource support.  Duh!

Jason