Consider the following recent comments by key regulators in the United Kingdom and the United States and a likely one from France:
In March 2012, Lord Turner of Ecchinswell, head of the UK’s FSA and a potential successor to Sir Mervyn King as head of the Bank of England, attacked “tricks, dissimulations and over-complexity” in the financial sector, adding that “The word innovation is being abused. Innovation ought to be a word we use about new drugs that improve human health, or new forms of agriculture that deal with the demand for food in the world or new forms of energy that deal with climate change.”1
In a March opinion piece in the Wall Street Journal US Treasury Secretary Timothy Geithner recently termed the pre-Dodd-Frank US regulatory system “tragically antiquated and weak” and blamed the severity of the financial crisis on the “failure to modernise” regulation, while lauding the 1,800 page Dodd-Frank law.2
Francois Hollande, the likely next president of France, has declared “war” on finance.
These statements tell us two important things about the future of financial regulation: there’s going to be a lot more of it and the people writing the rules do not believe that finance is important enough that they ought to worry about whether they get things right when they write those rules. The US, the UK and the EU are all going to be issuing more regulations that will complicate financial transactions in some of the world’s biggest economies.
This trend toward more heavy-handed regulation – and there really is no other way to describe the US Dodd-Frank act given that its 1,800 pages are just the opening step in a process that will yield tens of thousands of pages of regulations – makes the role of international financial centres critical if Turner, Geithner and Hollande are not going to succeed in sabotaging the global economic recovery.
IFCs provide competition for onshore governments, forcing them to at least consider the costs of regulations through regulatory arbitrage. That is often painful for the onshore economies, but it is a crucial role.
This is not an argument for anarchy. Regulations can add value, by assisting in creating stable markets, by enhancing the rule of law and by lowering transactions costs. The question is how to find the balance that adds value. IFCs like Barbados, the Cayman Islands and the Channel Islands (and many more) provide important competitive pressures to keep that balance right.
It’s not hyperbole to state that the world’s economy is under a serious threat from overly aggressive regulators. Yale Law Professor Jonathan Macey, one of the foremost experts on financial regulation, told The Economist in February 2012 that the Dodd-Frank statute is itself merely “an outline” and that the statute’s key impact will be the “willy-nilly” creation of new federal bureaucracies instructed to “go forth and do good”3.
It’s not just Dodd-Frank that is the problem, however. Paul Tucker, deputy governor of the Bank of England (and another potential successor to Sir Mervyn), recently suggested that Solvency 2 “risks being too complicated in its desire to introduce a ‘risk sensitive’ regime …
We need to be wary of regulators drowning in masses of data going beyond anything they can get their hands round”4. It is hard to imagine a more devastating blow to the world financial system than unleashing unconstrained bureaucracies “drowning” in data and with vague mandates to do good to flail away in an effort to satisfy the conflicting objectives contained in massive statutes like Dodd-Frank. Such efforts will destroy the certainty individuals and businesses must have to be able to plan their affairs.
Geithner, Turner and Hollande have lost sight of how wealth is created and their responsibility as public officials to enhance that process. Lord Turner is wrong to dismiss financial innovation as unworthy of our respect. Wealth creation requires innovation in finance, to find new ways to reduce transactions costs, to reallocate assets, to shift risks and to spur economic growth.
While some people may need the protection of a bureaucracy from their own folly and ignorance, the hedge fund investor, asset securitisation market participant or captive insurance company owner does not fall into that category – they can afford their own lawyer and contracts to protect themselves. Wealth creation requires regulatory frameworks focused on what governments can do to enhance economic activity, not to prevent it.
This is impossible without clear rules. As Prof Macey said in his interview with The Economist, “If you can’t understand a law by looking at it for eight hours straight, which nobody thinks they can do with Dodd-Frank, there’s probably something suspicious.”
Yet we are proceeding down a path in which the major economies see nothing wrong with imposing regulatory systems on the financial industry that no one can understand. That makes the forecast: storm clouds ahead.
- Turner takes aim at the City, The Times (London), March 14, 2012, http://www.thetimes.co.uk/tto/business/economics/article3350660.ece
- Timothy Geithner, Financial Crisis Amnesia, Wall Street Journal (March 1, 2012) http://online.wsj.com/article/SB10001424052970203986604577253272042239982.html?KEYWORDS=geithner
- Too big not to fail, The Economist, Feb. 18, 2012, http://www.economist.com/node/21547784
- Insurance, stability and the UK’s new regulatory architecture – speech by Paul Tucker, The Financial (March 14, 2012) http://finchannel.com/Main_News/Banks/105636_Insurance,_stability_and_the_UK’s_new_regulatory_architecture_-_speech_by_Paul_Tucker_/.