Saturday, January 12, 2013

“It's a Wonderful Life” On Regulatory Policy: Crimes Verses Mistakes

Ignoring theft

The third deficiency of the current regulatory focus presents less of a systemic risk to the financial system, but clearly creates a substantial risk of the different type.  One can hardly consider regulations just if they overlook stealing. 
Perhaps the policy wonks should come up with the simple regulation that overrides all their other regulation and states simply “no other regulation implies a right to take other people's money.”  It is when until uncle Billy loses a deposit, in other words until money disappears, that regulators and law-enforcement become involved.  In “It's a Wonderful Life” misappropriation of the depositors’ funds is among the most serious charges Potter levels at George when Potter really wants to be nasty. How refreshing!

The media, bank regulators, the judicial system, and policy wonks all seem to be totally unable to distinguish between out-and-out theft and perfectly honest activities.  For example, on Christmas eve day, the same day the WALL STREET JOURNAL reported the investigation into Regions Financial, the paper had an article entitled “MF Global Trustees Cut 'Gordian Knot.”  This second article reported on the current status of efforts of the courts in relation to MF Global”s bankruptcy. It was an amazing juxtaposition of a complete failure of our legal system and the waste of our regulatory system.
Recall that the banks are not being accused of taking depositors’ money: what has been in question is how they were investing it for the depositors.  Regulators are focusing on issues such as: Whether investments were prudent, were reserves adequate for the types of investments being made, and did banks adequately disclose their investment activity?  Those are important issues but pale compared to ensuring that no one is just stealing the money.

The situation at MF Global is totally different from that of the regulatory focus.  As the article reports: “In the months after the bankruptcy, trustees estimated that about $1.6 billion in customer money had been moved from its proper place in MF Global's final days.”  It's incredible that no one explicitly states the money was stolen from customers’ accounts.  These were not funds deposited with MF Global for use by other than the owners.
One should note this is very different from the example of Prime Reserve, a mutual fund that broke the buck.  In that case, the funds were at all times invested within the mutual fund for the benefit of mutual fund owners.  In the case of MF Global, funds from depositors were pledged, (i.e., loaned), and the proceeds used for the benefit not of the depositors but of MF Global.  In short, they took the depositors money and used it for their own benefit.  It is the possibility that a similar event occurred at Bailey Building and Loan that brings the law into play in “It's a Wonderful Life.”

MF Globel involves a violation of depositors’ intent as well as a phenomenal demonstration of dishonesty on the part of MF Global’s management.  It is a regulatory disgrace that this could be done.  So, one would suspect that given the emphasis on reforming our financial system there would be severe penalties for those involved and a serious effort to ensure that such regulatory loopholes are eliminated.  Instead, as reported in the WALL STREET JOURNAL article, the result is an agreement that “signaled a new détente over how money from the eighth-largest U.S. bankruptcy should be distributed and whether creditors or former customers of the company's brokerage operations should take precedence.”
“Regulators and plaintiffs' lawyers also are looking into MF Global's bankruptcy. Plaintiffs' lawyers have sued Mr. Corzine and other former executives of the firm, hoping they could win funds to compensate MF Global customers.”  One is forced to ask:  Why in the world is it necessary for customers to sue in order to get their money?  Common sense would suggest that one of the primary purposes of financial regulation should be to ensure that people do not steal other people's money.  Instead our regulators set up a framework that allows them to pursue trivial issues while ignoring what was clearly intended as a misappropriation of funds.

It isn't any wonder that there is active opposition to regulation?  Regulators have no one but themselves to blame for it.  They are not focusing on institutions that represent the greatest risk.  In addition, they seem to be more interested in pursuing witch-hunts, then protecting individuals from dishonest behavior.  The Hedged Economist considers this nonsensical behavior on the part of regulators extremely unfortunate.  A healthy regulatory environment would go a long way toward producing a more stable financial system and one that the public could trust.

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