More Comments on Principles-Based Regulation
1. I think that many people are missing an important feature of principles-based regulation, which is the role of audits in producing compliance. I will explain that in the next post on the topic.
2. One principle I want to implement is “Don’t scam customers, especially those who can’t afford it.”
I think that many people have poor financial knowledge. They don’t understand discounting to present value, so when they hear that they can “save thousands of dollars on their mortgage” by switching to biweekly payments, then do not realize that in present value terms these savings amount to very little. They don’t understand the concept of insurance, so they will pay a lot of money to protect against small losses.
We know a very poor woman who has bought “burial insurance” several times. Each time, she misses a payment, the policy is canceled, and she has to start over.
I am offended by the businesses and people who exploit these sorts of human weaknesses. I would actually feel pretty good about my “contributions” (taxes) if they were being used to protect potential victims of these scams and punish the scammers.
3. A second principle is, “Don’t exploit your government guarantee.” Yes, the surest way to keep banks from exploiting guarantees is to not issue any guarantees. But we are not in that world. Exploiting the guarantee means earning returns by loading risk onto taxpayers. You can do this by scrimping on management controls, by taking large bets, by maintaining too small a capital cushion, etc. In my previous post, I provided Kyle’s eloquent summary of why I do not think that rules-based regulation will succeed in stopping banks from exploiting guarantees.
4. If you assume malice on the part of regulators, then I will grant that principles-based regulation will fail. My claim is that bright-line regulation fails even if you assume no malice on the part of regulators.
5. The way I see it, common law is an “existence proof” for law that is not hard-coded into written rules. Police, prosecutors, judges, and juries all exercise discretion in our system. We can quibble over how much discretion is optimal, but zero is not self-evidently the right answer.
5. Evan Soltas, in an otherwise thoughtful post, writes,
He puts forth the idea of principles-based regulation in hope that it will reduce the regulatory burden incumbent upon firms.
I do no such thing. I want to change the nature of the regulatory burden. It is my hope that it will reduce increase the regulatory burden for “bad” firms (ones that are otherwise inclined to violate the principles) and perhaps reduce it for “good” firms.