By Arnold Kling
In my latest essay, I argue for principles-based regulation.
With PBR, legislation would lay out broad but well-defined principles that businesses are expected to follow. Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines. Finally, the Department of Justice would prosecute corporate leaders who flagrantly violate principles or who are negligent in ensuring compliance with those principles.
In principle, the advantage of traditional rules-based regulation is that the regulated entity knows exactly what is legal and what is not. With principles-based regulation, this is less clear until case law develops.
In fact, I would argue that in financial regulation, precision is a bug rather than a feature. You set up a game in which, I contend,
The bankers are always able to outmaneuver the regulators, staying within the letter of the rules while mocking their spirit.
No regulatory system is perfect. Any regulatory approach is difficult to implement. However, if I were regulatory czar, I would rather work with a principles-based approach than with a rules-based approach for issues like fundamental safety and soundness of insured institutions and basic consumer protection.