It really is very hard to come up with decent proposals to contend with our highly integrated, international, essential, and not-so-well functioning financial system. While some have developed general guidelines that sound attractive, figuring out how to implement them is quite another matter.
For instance, in a recent Financial Times comment, former Treasury secretary Larry Summers set forth “Six principles for a new regulatory order.” Number one was:
… there should be a strong presumption against having regulators competing to supervise particular institutions or activities. Experience suggests that even when firms do not have the option of switching, there are substantial risks that regulators will be co-opted. Adding “forum shopping” exacerbates the problem.
Well, yes, eliminating regulatory arbitrage is a very nice idea. but short of having a world government and a single financial regulator that manages everything from teeny credit unions and payday lenders though uber-banks, there isn’t a simple prescription for how to make this happen. And having a single regulatory framework has its own drawbacks. Henry Kaufman has argued for the formation of a high powered regulator to be aligned with the Fed to supervise the biggest, most complex institutions. But having horses for courses regulators is at odds with Summer’s idea of more integration.
From an interview in the Financial Times:
Mr Kaufman said a distinctive feature of the financial crisis was “much greater lapses in official supervision and regulation than in earlier periods”.
He said there should be a new federal regulator appointed who would work with the Federal Reserve but who would have responsibility for “intensively” regulating the 30 or 40 biggest financial firms. Failure to do so could lead to a “crisis that’s bigger than the one which we have today”.
“The supervision of major financial institutions requires deep skills in credit, deep skills in risk analysis techniques and it requires within that organisation, very skilled, trained professional people,” Mr Kaufman said. “That is lacking in the supervisory area in the United States.”
So while it is important to get agreement on the general thrust of new approaches, it’s also key not to let good ideas, particularly ones that are practical, go by the wayside. The Financial Times featured one today in a comment by Charles Goodhart and Avinash Persaud, “A party pooper’s guide to financial stability“:
Much attention has been paid to the fraught task of aligning bankers’ bonuses to longer-term outcomes. But it will be easier to amend supervisors’ pay, to similar macro prudential effect. If supervisors received large annual bonuses that were withheld for five years and paid conditionally on successful supervision during this period, they might be more willing to remove the punch in time – thereby limiting bankers’ bonuses in the first place. To avoid excessive regulatory zeal we would need independent assessment of supervisory success, with some input from the industry.
It would need to consider such issues as widening access to finance as well as minimum cost to the taxpayer.
Because America, unlike much of the rest of the world, lacks a tradition of elite, career bureaucrats (they exist in a few places like the Department of State but aren’t part of the national psyche), we have trouble with the idea of paying them at anything approaching private sector pay scales (although the folks at the World Bank are pretty well compensated by virtue of tax breaks and very generous pensions). In Europe and Japan, the formulas vary, but one factor that is unlikely to operate in the US (at least for some time) is that the mandarins are held in high esteem.
But there is a more basic issue. If you want to prevent corruption in government and get good people you need to pay them. Singapore provides a casebook example. In the late 1950s, it has a diseased bureaucracy it had inherited from the British. Lee Kwan Yew undertook a multi-pronged effort to transform the government, which included instilling ideas that no doubt sound alien to Americans, such as having government officials, including politicians, be part of a meritocratic system. Compensation played an important role in this transformation. Top officials were very highly paid. The transformation was radical and successful. Lee Kwan Yew was attentive to the role of compensation:
On 22 March 1985, the then Prime Minister, Lee Kuan Yew, provided an eloquent justification for his government’s approach in combatting corruption when he explained in Parliament why the salaries of his cabinet ministers had to be raised. According to him, the choice was a simple one: ‘Pay political leaders the top salaries that they deserve and get honest, clean government or underpay them and risk the Third World disease of corruption.’
The Goodhart/Persaud sketch has merit. Warren Buffett has for many years used a long-term incentive scheme in his insurance business (my information is no doubt dated, but the top executives got moderate salaries and shared a bonus pool of 15% of the profits, determined and paid out 5 years in arrears when the loss experience of policies written could be determined with certainty).
Given the more ambiguous nature of the regulators’ goals, coming up with the right formula would be tricky, and it would probably need to be reviewed and tweaked. Coming up with a good oversight body is also not trivial, and making sure the regulated firms can provide information without using the oversight group as a lobbying platform is not trivial. Sadly, finance savvy and public-minded citizens like Paul Volcker are in short supply to begin with and are a dying breed. I know contemporaries who have the right skills and mindset to play such a role, but they are not high profile. That sort of highly competent, disinterested person in many cases would lose out to someone more visible. But in America, the well known are typically well-connected, which also means more susceptible to influence.
Despite the complexities in making an idea along these lines work out, it has high payoff and comparatively low cost relative to other options. I hope it gets some traction.
I am very supportive of Kaufman’s proposal that regulatory body for top tier financials be _independent_ of the Fed. There are just too many internal conflicts of interest in the way the Fed operates now with regard to multiple mandates.
I have no problem at all with paying top tier regulators and bureaucrats big money: they have real responsibilities with long term costs. A larger problem, though, is that there is no real career track for folks performing such functions. It’s hard to see entry level staffers rising to mission leadership, so that most key public administrators are likely to be recruited from the industries they will supervise; that’s a problem, and hard to get around.
Something mentioned in neither of these proposals is that said top tier financial regulator needs both a highly skilled research staff and access to information at other regulatory bodies. For example, the lead financial regulator has to have SEC and CFTC data to really get a handle on capital flows. It is easier to see the research pool attracting signficant talent, and also serving as a corrective for ‘from the industry’ recruits who may be too close to the mindset of the markets upon arrival.
kline is right. There is enough prestige in the top government jobs to attract good people. However, there is zero incentive for good people to take other jobs in financial, securities, tax, or regulation authorities.
Congress addressed this somewhat for the SEC and Fed by boosting their pay to some extent. However, pay in those agencies still lags far behind the private sector. And outside those areas, good lawyers can get paid 3 or 4 times as much money in the private sector, and save 7 to 12 times as much money for retirement.
The FDIC tried a merit / pay-for-performance incentive program, but it didn’t last long for some reason (not sure why).
Didn’t everyone say that we needed to increase CEO’s pay? And what we got was golden parachutes so whether they looted the company or not they would get lots of money and a golden parachute?
You can’t pay for ethics, at best it reduces temptation.
Has anyone forgotten Acton’s “Power corrupts and absolute power corrupts absolutely”?
And there are many activists who wish to punish more than regulate. To do more than they are authorized to.
But even now Generals exit and become high-ups in defense contractors.
I would counter with things like the Freedom of Information Act and other things so that the data would appear on the internet, or otherwise be easily accessible.
Even so, rules can’t replace wisdom. SIVs, SPVs, are all there to hide things – often legally – from the public or regulators. No regulation can be constructed that a well paid army of lawyers can’t get around.
And the USA (or the UK, etc.) is not Singapore. I don’t know if it was here that I read about Denmark and it’s leveling policies, but both Singapore then and Denmark now isn’t the USA. For good or ill, we can’t transform the USA into either or the best of both no more than we can transform Iraq into a democracy.
Something will change of necessity, but it might start with Congress. Read Johnston’s “Free Lunch”. Until that stops any “reform” will only serve to block competition and enrich those at the trough.
“However, pay in those agencies still lags far behind the private sector.”
So why not lower the pay in the private sector?
“I have no problem at all with paying top tier regulators and bureaucrats big money: they have real responsibilities with long term costs.”
Let me go on the record as saying that I have no problem with it either! Not that I have any personal motivation in the matter . . . ;)
anonymous 8:08 is correct, the pay scale for certain regulatory agencies is higher than for the rest of the government, precisely to try and better compete with private sector hiring. Still, there is a “ticket punch” mentality, where people work for the regulators for a few years, then go into private sector and make a large multiple of their former government salary. That results in a shortage of experience, with the long-term employees being those actually enjoy the government work or (like myself) are hopelessly addicted to the regular schedule and generous time off, and unfortunately, a handful of those who can’t find work elsewhere (not many, but yes, there are a few.)
Regarding benefits, government workers do have more generous schedules and time off, and more job security, so their pay should be slightly lower. But still, the gap at this point is so large that it makes it difficult to retain good employees. Reductions in the pay of private sector jobs will help, but that gap is likely to stay for the immediate future.
For what it’s worth, some regulatory agencies have pushed for pay-for-performance systems linked with higher pay, but much of that has been blocked by the government unions, who see the reforms as a threat.
“It’s hard to see entry level staffers rising to mission leadership, so that most key public administrators are likely to be recruited from the industries they will supervise; that’s a problem, and hard to get around.”
I think some movement between industry and regulators is essential. It can be valuable to get insights from former insiders who know what is going on when the regulators aren’t looking; too many people who have only worked in government, and there are likely to be more “surprises.”
anon 8:08: “However, pay in those agencies still lags far behind the private sector.”
a: “So why not lower the pay in the private sector?”
anon 8:08: I haven’t heard of any effective proposals to lower pay in the private sector for lawyers, bankers, traders, and fund managers.
As Yves’ pointed out, private sector-level compensation for public officials is in stark contrast to the methods congress is currently employing (fear)…and, as Peter Gibbons from Office Space reveals, “that will make someone work just hard enough not to get fired.”
“(Sen.)Cantwell said she was prepared to hold up the CFTC appointments – including the appointment of acting Chairman Walter Lukken to full chairman – until the CFTC acts.
“During the Enron debacle, we used every tool we could to get the (Federal Energy Regulatory Commission) to get them to do their job…and if that’s what it takes to get the CFTC to do their job, we’ll use every tool we have,” Cantwell said.
“I do not like the revolving door between these agencies and the industries. They are not supposed to be the fox in the hen house, they are supposed to keep the fox out of the hen house,” Cantwell added.”
imho, the desired compensation schemes are forthcoming, in the form of jobs at makers of online markets that provide people w/ new & improved ways to develop, showcase and earn money from expertise. these markets-makers are embryonic-verging-on-fledgling, but can be expected to do big business in the coming years.
of course, these companies can only prosper to the extent that people must genuinely add value to earn money.
as these companies grow, then, they can be expected to work hard to see to it that politicians and regulators impose policies and regulations that make the economy increasingly inclusive and meritocratic (e.g., universal pre-k, properly regulating the financial sector).
Following the same principles people use to balance their checkbooks and have a CPA re-examine the numbers…whadda concept.
A better idea is to ask Congress why they don’t allow the application of general accounting rules to every entity including themselves.
Are we sure that the ordinary GS scale fed regulators are so underpaid? Fed. lawyers with good reviews and experience earn in the low $100,000 range. While lawyers in the big firms earn signficantly more, there are very few of them and the average lawyer earns significantly less. Furthermore, the last time I saw the relevant statistics, there was very little turnover among fed. lawyers and a lot of competition from very good lawyers for any fed. openings.
Most Fed regulators, like most fed scientists, become feds for reasons that have nothing to do with getting rich. They are paid enough to have a very nice comfortable lifestyle, in the approximate 90the income percentile for American families, and they derive their satisfaction from other sources than mere wealth accumulation.
There is another, more important reason to not pay feds much more than the 90th income percentile for American families, despite the disparity between that salary and the incomes for other top professionals in their field. Unlike the Brits and other Europeans, we should not want an elite federal bureaucracy. We should not want our public servants to lead lives divorced from the lived experience of the rest of the population. We should want our public servants to identify with the interests of the rest of us underpaid plebians and to to govern in their (our) interest and not in the interst of the regulated. Its a matter or republican principle.
BTW I’m a former fed lawyer, now happily earning much less as an academic.
Anon of 9:14 PM,
Thanks for your comments. To clarify a few point:
1. Anyone who is capable of understanding and therefore regulating complex instruments will have to have had real experience with them. You are not going to get, say, a four year person from the Street in a regulatory position for $100K. That’s less than the starting salary of a new MBA. They won’t have earned enough cumulatively to be indifferent to money. That isn’t to say you try to match the Street, that’s a non starter. but something incentive based (as the article suggested) would be a way to bridge the gap.
2. The bureaucrats in Singapore were hugely well paid, but they needed to overcome a tradition of corruption. Readers in Europe are welcome to correct me, but the elite bureaucrats are elite in terms of status, not pay, and therefore do not live at a different level than society at large. In France, they come from the best schools (historically, France did a very good job of identifying talented children from poor background and making sure the elite schools were indeed populated by the best and brightest; the Haute Ecoles were thus meritocratic. I am under the impression this is far less true than it used to be); in Japan, from Tokyo University law school. And in Japan the bureaucrats are poorly paid but held in the highest regard. Those jobs are coveted.
I think all this regulatory reform talk is putting the cart before the horse. The main problem at this juncture has been a radical, anti-regulation government that has essentially refused to uphold the laws of the land. This is what needs to be reformed.
Where in the regulations does it allow liar and no doc loans ? Where in the regulatory code does it allow off balance sheet vehicles, put in place for the purpose of assuming greater leverage than the regulations allow ? These are examples of criminal acts of fraud backed up by a slew unethical operating tactics designed to undermine the existing law.
The last eight years have been like Salinger’s “Lord of the Flies”. The actors know no bounds. Psychologists call it sociopathy and that is the main problem.
THe election of grifters like GW and Cheney was like throwing a switch, turning on grifters of every stripe. The country is sick with aristocracy disease.
How do we fix that ?
The good lawyers I have met have pretty much been motivated by a combination of money and prestige. They can all work at large law firms if they want to, only do otherwise to make more money or prestige doing something else.
These lawyers are the reason that SIVs, and other off balance sheet techniques are legal. They lobby FASB, the Fed, the SEC, the Treasury Department, Congress, and so on for favorable laws and regulations. They help structure transactions and reporting to take the maximum advantage of the favorable rules. Staff on the Hill and in regulatory bodies can’t compete with these people. This differential in pay and prestige is a major contributor to heavy use of legal tax shelters, legal avoidance of securities disclosure rules, legal off balance sheet financing, and so on.
Unless you offer good people jobs with an attractive combination of pay and prestige, you’ll have trouble recruiting and retaining people. It’s a competitive world and good people always have lots of opportunities.