Keep it Simple

In his NY Times' column, Joe Nocera looks at JP Morgan CEO Jamie Dimon's question of has anyone bothered to look at the cumulative effect of all the new rules to see if there is a net benefit.

Lo and behold, he finds Karen Petrou.  She has been tracking the new rules and what she has found is "complexity risk".

Complexity risk poses two problems.  First, it is harder to monitor compliance with the new rules and smart bankers will find a way to game all the new rules.  Second, all the new rules don't necessarily make the financial system any safer.

Her solution:  simpler rules and a reliance on the combination of market discipline and transparency.

As regular readers know, requiring banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details brings market discipline to the financial system.

Equally importantly, it allows for the rules to be dramatically simplified on a global basis.  For example, this blog has discussed how disclosure would dramatically reduce the incentive for banks to take proprietary bets and as a result how the goal of the Volcker Rule could be achieved without the complexity of the rule itself.

What if Jamie Dimon is right? 

What if the chief executive of JPMorgan Chase is not just blowing smoke when he complains that the country — and, indeed, the world — has imposed so many new rules on the banking industry, some of them overlapping, others seeming to contradict each other, yet others whose sole purpose seems to be to weigh down the industry, that they threaten to do as much harm as good? 

Last summer, you’ll recall, Dimon confronted Ben Bernanke, the Federal Reserve chairman, at a conference and asked him: “Has anyone bothered to study the cumulative effect of these things?” Just last week, during JPMorgan’s earnings call with analysts, Dimon complained that Europe’s “regulatory policy, government policy, central bank policy — it’s not coordinated. It’s making the situation worse, not better.”... 

What has caught me up short recently is the emergence of a new critic of the banking regulations that have been pouring forth from Washington and Europe. Her name is Karen Petrou, and she is the managing partner of Federal Financial Analytics, a consulting firm that, among other things, analyzes bank regulations for clients. 

Unlike many in the banking industry, Petrou is not ideologically opposed to regulation. For instance, she was a critic of the lack of regulation that allowed so many sleazy subprime mortgage originators to emerge from the precrisis ooze. 

Yet, now, she’s worried about something different: that the hundreds of new mandates required by the Dodd-Frank law are creating a new kind of risk. She calls it “complexity risk.”...  

Why does complexity risk matter? One reason is that the more complex the rules are, the greater the likelihood that smart bankers will find ways to game them. Another is that contradictory regulations, however well meaning, simply don’t make the system safer. But the most important reason is that complexity risk is having an effect on business — and that’s not helping the still-fragile economy.... 

Petrou offers a series of solutions, revolving around simpler regulations, a reliance on market discipline and transparency. 

She also calls for the regulators themselves to be held accountable, something that is nowhere to be found in Dodd-Frank, despite their obvious shortcomings in the years leading to the financial crisis. 

However you feel about banks — and I know that many people harbor enormous, justifiable anger at what they did — our economy can’t function without them. And they needed to be regulated. But three years ago, overly complex securities were one of the root causes of the crisis. So why, then, do we have faith that overly complex regulations will prevent the next crisis? Sad but true: they won’t.