Feedback mechanisms

The optimist says the glass is half full.  The pessimist says the glass is half empty.

 

The engineer says the glass is twice as big as it needs to be.

 

The issues of failed regulation, and failed political systems more generally is not one of left or right philosophy in particular, but rather mis-aligned feedback mechanisms.

 

When my house gets cold, my (properly engineered) thermostat simply turns on the furnace.

 

But when Congress designs the process, and the house gets cold, the Congressional thermostat turns on the lights, opens the curtains, plays loud music and starts mixing drinks, on the theory that neighbors, believing there is a party, come over, and their body heat warms the house.

 

Doubt that?  It is in fact not a joke.  Consider how Congress tries to monitor financial markets....

 

******

 

It’s almost a toss-away line: “Politicians want to overrule the boards and shareholders who normally determine CEO salary and bonuses.”

 

But if boards and shareholders had in fact determined CEO salaries, if they had set up rational feedback mechanisms and enforced sound risk management, then CEOs would not have gone so far off the rails.

 

The real issue in capital markets is the Rube Goldberg apparatus that passes for regulation. Whatever else history records, the current financial contretemps did not result from lack of regulation. Rather, it arose from human weakness on both sides–government AND industry. The amorality of industry is widely discussed. What is too often ignored is the human weakness in government.

 

Consider the specifics:

·         Congress delegates to SEC, which delegates to PCAOB/FASB to set rules for accountants, who then compel GAAP and SarbOx reporting to shareholders, in the vain hope that they will in turn force directors to rein in managements. (.)

o    Perverse outcome 1 – Auditors deny blame for fraud, and get rewarded with more work under SarbOx.

o    Perverse outcome 2 – Rating agencies in epic fail, and get rewarded with more work under TARP.

 

·         Coming along after the fact, shareholder suits are too blunt a corrective. They create uncertainty, and raise D&O premiums, but have no effect on management and emphatically do not discipline boards.

·         Meanwhile SEC also allows SROs and exchanges to set their own  rules.  As does CFTC.

·         Then Labor, by way of ERISA, tries to define prudent investing, which means delegating authority (but not responsibility!) to rating agencies, who are paid to say “yes.”

·         Beyond this general corporate regulation, there is special banking oversight, including the Fed, OCC, FDIC, and OTS. On top of that come the state banking regulators.

All of that ignores the fact that the sole proper role of the Fed is to make sure the Treasury does NOT cheapen the dollar and thereby rob investors by inflationary default.  (cf. Bagehot vs. Hankey.)

 

With so many moving parts involved, no specific party can ever be called to account. No one gets blamed for failure.  Being mortal, bureaucrats love power just as much as private enterprise loves money.

 

Even worse, it is far more profitable to game the rules than to enforce them. So the best minds are squandered on games. Witness the over-reaction of SarbOx, the waste of money on useless reporting, and the ease with which companies avoided real change.

 

Such a scheme is far worse than nothing at all, for it deludes us into thinking that Someone, Somewhere, is Responsible.

 

Free markets are great, but that’s not quite what we have now.

 

You need to be a member of Global Risk Community to add comments!

Join Global Risk Community

Votes: 0
Email me when people reply –

Introducing the Global Risk Series - Book 1 Risk Management How Tos

Dear GlobalRisk Community member, Our community’s mission is to foster business, networking and educational explorations among members. Learn from some of the top experts in the industry as they clearly explain how to approach the most important Risk management concepts. Check out their expert tips and use the link at the end of each article to navigate back to the website to leave your comment or ask a question.   Some of the topics include: How do you Explain Risk Appetite?  How to Prepare a…

Read more…
16 Replies · Reply by GlobalRiskCommunity Mar 21
Views: 1134

[Free COVID-19 Framework] What's the path to recovery look like?

We created a free presentation (attached), which discusses both global and organizational impacts of the COVID-19 pandemic, along with critical actions organizations should take immediately. This presentation introduces a framework that helps regions and organizations navigate a path to recovery via 9 potential scenarios. These scenarios capture outcomes related to GDP impact, public health response, and economic policies. The presentation also breaks down 6 immediate and critical actions…

Read more…
4 Replies · Reply by Steve Diaz Jul 8, 2023
Views: 244

If risk management is about decision making, are current risk management solutions irrelevant?

Now that the updated COSO and ISO risk management standards emphasize a connection to enterprise objectives and decision making, does this mean ERM and GRC solutions focused on risk registers and regulatory compliance are missing the true value of risk management?Will current risk management solutions evolve to integrate more decision support functionality or will standalone prescriptive analytics and other technology solutions take a more prominent role in enabling risk-informed…

Read more…
3 Replies
Views: 176

A question related to classification of instruments between trading and banking book.

We have an interesting question from one of our members.       "We usually perform OTC FX transactions with clients backed-to-back on the market (with Banks). Now we are going to perform a FX swap (i.e. Spot + forward) JPY/EUR for the Bank account for 1 week at the longest. The purpose is to get EUR place @ CB for LCR compliance purpose (no trading purposes). Bank's Management think that this should be considered as a trading position and therefore be classified within the Bank's trading book.…

Read more…
5 Replies · Reply by Prisha Singh Dec 26, 2023
Views: 381

Plunging oil prices: curse or blessing in disguise?

The recent sudden crash of oil prices has had a major impact on the world economy, leading to many troubled faces in the international arena. The Russians fear the effects of yet another powerful hit on their economy, Venezuela seems to be considering default and the Americans are weary of the consequences for its young and emerging shale oil industry. And then you have the Middle East, where the smallest match is enough to ignite the largest fire. But are these worries really justified or…

Read more…
1 Reply
Views: 113

    About Us

    The GlobalRisk Community is a thriving community of risk managers and associated service providers. Our purpose is to foster business, networking and educational explorations among members. Our goal is to be the worlds premier Risk forum and contribute to better understanding of the complex world of risk.

    Business Partners

    For companies wanting to create a greater visibility for their products and services among their prospects in the Risk market: Send your business partnership request by filling in the form here!

lead