Regulatory Reform

Robert Waldmann

has been playing hooky. Look it’s the end of the semester. My actual job involves some actual work these days (ETA of a Thesis defense 40 minutes). Also, I note no popular demand for my opinions on the Obama administration plan to reform financial regulation, and I still know jack about finance.

So I’ll just comment on Paul Krugman commenting on the plan. First, I note, that this is not a jeremiad — the shrill one sees a half full glass. So the reform must be better than I expected. He does have two criticisms (after the jump)

1) Ratings Agencies

Furthermore, the plan says very little of substance about reforming the rating agencies,

WTF ! Have I missed something ? Has a law already been passed forbidding ratings agencies to charge the entities whose securities they rate for “consulting” ? I mean Christopher Cox said that had to be done. Obviously the system can’t work with blatant open corruption of ratings agencies.

Let’s see

The new rules are aimed at bringing more accountability and transparency to the bond-rating system. They effectively prohibit any firms from rating debt they helped structure and bar analysts from accepting gifts or entertainment exceeding $25 in value from the issuers of the debt they rate.

Oh excellent. As far as I can tell, a ratings agency A can charge flybynight financial for consulting on instrument A and rate instrument B and ratings agency B can charge for consulting on instrument B and rate instrument A.

The rule has to be that issuers of instruments have no flexibility at all about how much they pay ratings agencies. Yes that means all new instruments *must* be rated and issuers must pay a standard fee to each of a list of regulator approved ratings agencies unless and until some regulator decides the agency is worthless and takes it off the list of federally imposed mandatory raters, because it’s ratings were not good enough predictors of default.

Come on, fool me once, shame on you, fool me twice … you can’t fool me twice. Back in the good old days the integrity of the ratings agencies was a precious and miraculous national treasure, but wishing for a second such miracle is not a plan.

1) Executive Compensation

“Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.

Here, strangely, I had a concern about strict limits on executive compensation packages. Some fool argued that it would keep the brightest people out of finance. That would be a feature not a bug. Unfortunately, the active margin is work for an investment bank or set up a hedge fund. If the few people in finance who actually have a clue all set up hedge funds, then the all of the people running (and trading for) investment banks which are too big to fail will be fools.

A simple ceiling on compensation for officers of corporations will just make the competent officers of financial corporations become partners in hedge funds.

Of course Krugman understands this (as does Brad DeLong and every hedge fund manager with whom I am personally acquainted). The rules have to tie compensation to long term performance — that is require bonuses to be paid only in non-transferable shares or whatever the hell they do in silicon valley.