Strengthening the antlers
By Daniel M. Ryan
In last week's State of the Union address, U.S. President Barack Obama proclaimed the need for stronger regulation on the financial-services industry. Given that it's one of the most heavily regulated industries in the economy, President Obama's proposal is akin to saying that the Hood needs to be more lightly policed. After all, people are complaining.
There's a case study that's included in most biology texts, as it makes us stop and think. A long time ago, an ungulate called the Irish elk grew antlers that were much wider than even a moose's: three meters, weighing forty kilograms, or more than a hundred pounds' worth of ten feet. We're inclined to believe that bigger antlers are better, because antlers serve as armaments in the ungulate mating game. A male with huge antlers can best everyone else, so we reason: it's the same line that's used with guys and big muscles.
Of course, this case study has a trick; the Irish elk is extinct. It turns out that its gargantuous antler rack was the cause: as the antlers grew and grew, the beasts found them heavier and bulkier. In addition, the nutritional maintenance grew with their antlers. Consequently, the ones with the biggest antlers – the likely winners in the mating game – went malnourished in the winter, once climate change made their food less plentiful.
It's a similar process with regulation. The more regulations are enacted, the more there are to enforce. Regulators try to pick their spots by concentrating on the ones that are easy to enforce, or elicit outrage if flouted. Insider trading rules are a classic example of the latter in the United States. On the other hand, every person-day devoted to watching insiders is one less person-day for, say, finding too-aggressive salespeople. As a result, many regulations are not enforced at all. Experienced regulatees, I can assure you, know how to pick their spots too.
There's no need to take the word of a humble pundit on this matter, when this particular pundit is echoing B.C. Securities Commission Chairman Doug Hyndman. "The B.C. Securities Commission chairman Doug Hyndman issued a warning on Feb. 23, 2009, saying think long and hard before cooking up a slew of new securities regulations…." The exchange that was at the heart of British Columbia's financial district, the old Vancouver Stock Exchange, was notorious in its day. Another source in that article, Jim Matkin, explains why: "'The old VSE lost credibility not because there weren't enough regulations, but because the regulations were not enforced.'" (Do the names "Bernie Madoff" or "Allen Stanford" resonate with this quote?)
Regarding regulations, we seem to have reached the Irish elk level. Just as that animal could thrive when the climate was agreeable, the regulatory state thrives when people are anxious to comply. Once they see that compliance is largely pointless, except for certain flash spots, the climate has a'changed. As noted above, a huge slew of regulations make spot-picking necessary, and leave wider enforcement gaps. It is, after all, easier to promulgate a regulation than it is to enforce it – just as it's easier to come up with a good plan than to buckle down and implement one. Murphy's Law combines with Parkinson's Law and the first law of economics – people gravitate towards ease and rewards – to make for a potent regulatory carcinogen.
Back in the days when common sense was more prized, this tendency was recognized by regulators. The hit-upon solution was to make normal business practice licit. Consequently, people in the industry complied simply by working normally. This model did stifle innovation, did banalize the regulated industry, but it also made sure that normal people did not become regulation-breakers by accident. This old standard is what people appeal to when they complain that such-and-such regulation or law "criminalizes normal business practice." The most notorious exception to this rule in America is environmental regulation, perhaps because President Nixon never found a Joe Kennedy figure to become the first EPA director.
We've long gone past those days, in large part because the number of regulations has exploded. As a result, there's often an 'unregulated' air to heavily-regulated industries. In point of fact, though, a heavily-regulated but laxly-policed industry is worse than a minimally-regulated one. When regulations are few and well-written, they're easy to remember and straightforward to enforce. Separating the complaint from the non-compliant is straightforward too.
On the other hand, a hundredweight's worth of regulations is all-but impossible to read through even for speed readers. No-one knows on her own whether she's compliant or non-compliant. If the regulations are well-written and enforced common-sensically, then it makes little difference. Once either is gone, though, then the compliant become the suckers instead of the standard-bearers. A gulf cleaves regulator and regulatee, leaving scofflaws on the one side and ideologues on the other.
President Obama, and his likesakes in other nations, can't really be faulted for answering what is clearly a populist call. It's up to us to think things through a little more, perhaps by recovering what our grandparents knew and we lost. This thought experiment may be of use: what one law would suffice to replace a particular slew of regulations?
It's a tough question for any sector, given the need to avoid throwing forthcoming babies out with tomorrow's bathwaters…as did Marx. It's one worth asking, though. More than morals are strengthened by practice and exercise.