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Rob Sama Grand Plan – Financial Regulation

Rob Sama Grand PlanWe have heard a common refrain from the left since the economic crisis hit. The refrain goes that the crisis was due to there being no financial regulation during the Republican years. It was as if a switch had been turned off at some point in the last 8 years, and now it’s time to turn it back on. As if we had a brief experiment with no-holds barred Laissez-Faire Capitalism, and it didn’t work, and now it’s time to return to a more sage time of managed markets.

When asked to specify which regulations, exactly, were repealed, the usual fallback is that the ban on bank ownership of brokerages and insurance companies had been repealed by the Gramm-Leach-Bliley Act. But of course, this doesn’t make an ounce of sense, as cross ownership between banks, brokerages and insurance companies was clearly not the cause of our current economic turmoil (as Phil Gramm himself refuted). Government intervention into the housing markets was, which was the subject of my last post in the Grand Plan.

But that is not to say that the current regulatory regime that we have in place is fine as is. We do need to make changes. But the operative question is: what do we hope that these changes will achieve? To answer that question, we will dispense with the mantra, “Regulation good, markets bad” from the left and the imagined, “Markets good, any regulation at all bad” mantra from the right, and instead set out to determine what it is that we want from our financial regulations, and then set out to make some modifications to our current system to better achieve those ends.

So what are those ends that we ought to be seeking out? Let me name the important ones that come to mind:

  • Transparency: Investors ought to be able to know what it is they are buying. Basic financial information should not be obscured, and meaningful disclosure should be required.
  • Liquidity: The ability to buy and sell financial instruments on the open market should not be hindered more than necessary.
  • Price Discovery: In a sense price discovery is the culmination of the above two principles. Investors ought to be able to determine a value for a good or service quickly. In addition, investors ought to be able to quickly compare relative prices across comparable offerings.
  • Protection From Fraud: Investors ought to be protected from fraud, to the extent that they can be without being protected from their own stupidity (in other words, some people are so stupid as to seek out fraud, and they cannot be protected by any amount of regulation). I should emphasize here the distinction between this and any attempts to alleviate a buyer from asymmetrical information. Asymmetrical information is the difference in knowledge about a product between the seller and the buyer, namely the one party (typically the seller) always knows more. While transparency can alleviate that problem, it will never fully eliminate it, and eliminating it is not a realistic goal. Fraud, on the other hand, is when the seller uses deception to sell a product, which is an entirely different thing.
  • Enable Competition: Competition is what creates redundancy in the financial system. A financial services industry dominated by a few giants creates systemic risk in the event of failure.
  • Reward Wealth Creation/Punish Wealth Destruction: This seems obvious, but it isn’t always obvious. Basically, you want to reward good economic activity, and punish bad economic activity, and not the reverse. Business is not a charitable enterprise.
  • Align Interests: Interests among financial parties ought to be aligned. An investor ought not worry that the manager of his money has different goals than he has, thereby taking inappropriate risks.

I’m going to break this down into two categories: regulations that effect industry and those that effect markets. In other words, those that effect companies who stock (may or may not) trade on Wall Street, and then again on those who do the trading on Wall Street.

Industry Regulations:

Repeal Sarbanes-Oxley
Sarbanes Oxley was passed by congress in response the Enron scandal, which cost investors billions of dollars. In order to understand just how silly Sarbanes-Oxley is, we first need to understand what happened at Enron.

Enron engaged in a number of highly risky strategies, strategies which had not paid off well for the company. Accordingly, Enron’s upper management engaged in a number of accounting shenanigans to hide what they had done, hoping that later they would be able to, in effect, pay back the losses incurred with future year profits.

Now what Enron management had done was already illegal. What’s more is that Enron’s auditor, Arthur Anderson, caught the accounting fraud. What happened next is rather unbelievable; Aurthur Anderson colluded with Enron management to let the fraud pass for a year, with the expectation that the company would recover in the next year, and then the fraud of the previous year wouldn’t matter. At a minimum, management would have bought themselves a year to fix things, but absolutely, positively they’d need to come clean in the subsequent year.

Of course, this is not at all what auditors are supposed to do.

There are a number of reasons why Arthur Andersen went along with the crackpot Enron plan, but we’ll get to those in a bit. First, let’s look at what the government passed in response to this discovered fraud: Sarbanes-Oxley.

Sarbanes-Oxley does a number of things, including making the CEO sign off on the financial statements as the CFO and the auditor currently do. But the main thing that it does is make a company certify that its internal controls are in order. That means that appropriate approvals are given at every level of an organization for any action to be taken, that all accounts are reconciled, etc. Basically, it’s a bottom’s up approach to ensuring that the assets are protected and that the numbers are right, stopping small missteps and errors at the lower levels of an organization from accumulating into material misstatements.

Do you see the problem here? In response to collusion by executive management with external auditors, the US government (by a vote of 99-0 in the Senate and 423-3 in the House) voted to create a stranglethorn of rules designed to catch accumulated small errors at the lower levels of an organization and did little to prevent a recurrance of what really happened at Enron. This is beyond stupid (as nearly anything that the Senate does by a vote of 99-0 is). Let us enumerate the ways:

  1. Congress reached for a grab-bag wish-list of items that the accounting industry had long lobbied for , and just passed them without thinking. The accounting industry wanted these rules because a) it would create lots of work for them to get everybody certified and b) once certified, it would become nominally easier to perform the same financial audits that they had previously performed (and would presumably continue to perform at the same cost).
  2. The accounting industry was in large part to blame for this mess, and should not have been rewarded with passage of their wish-list!
  3. In response to fraud at the top of an organization, congress passed a law designed to stop it at the bottom. Congress in effect closed the wrong barn door! It really doesn’t get any more stupid than that.

There is a final point that needs to be pointed out with respect to Enron, one that must be completely understood: You can NEVER stop collusion between a criminal and an enforcement agency until well after the crime has been committed. I’m going to repeat that in italics just so it really sinks in:

You can NEVER stop collusion between a criminal and an enforcement agency until well after the crime has been committed.

Consider an FBI agent who decides to collude with the local head of the mob, thus enabling a 30 year crime spree. It’s happened. And while the politician’s instinct is to grandstand and say “We’re going to make sure this never happens again” they can’t actually follow through on such a promise, any more than they could claim to prevent all crime. The best you can do is promise to get to the bottom of it when it occurs, and prosecute fully when it happens.

So the problems with Sarbanes Oxley are that it is inordinately expensive to comply with, it does nothing to stop another Enron, and it rewards the accounting industry that enabled Enron to happen in the first place. Oh yeah, one more thing: its costs are so onerous that it has basically stopped all IPO’s in the United States. So Sarbanes Oxley has to go. Just repeal it. There’s a much better way.

Insurance Instead Of Assurance

The audit industry often refers to what they do as “assurance”. Namely, they validate what companies claim is there and what their activities have been (from a financial perspective). Audit partners are personally liable for their errors, and pay hefty insurance premiums as a result. In fact, the audit industry is the 2nd most sued industry in the country after doctors.

But the whole idea of providing “assurance'” is farcical. It is vague and absurd. Asking anyone to put their personal assets on the line for such a thing is silly, and in the case of most public companies, the assets of an accounting firm’s partners aren’t going to cover the damage from a misstatement anyhow.

Finally, nobody’s interests are aligned in the current setup. The audit partner’s concerns are with keeping the client and keeping costs down. Thus he underpays his field staff, and often gives in whenever he and his client disagree over the results of an interpretation of the accounting rules. The staff, for the most part, just want to do their three years to get certified so they can get out, and they’re not particularly motivated to do their best work because they’re overworked and underpaid. And management has no incentive to get things right because there’s little punishment for getting things wrong.

So here’s what ought to happen: public companies get insurance, and ditch the assurance. Insurance would cover a specific max set of damages, as determined by shareholder vote, with a deductible paid for by management in the event of a material misstatement requiring damages to be paid. Finally, insurance premiums would be based on the quality of the books maintained by management, thus insuring that quality controls are kept, but only in a cost beneficial way.

So consider what this does. Under the Grand Plan, companies will buy insurance as required by their shareholders to cover potential misstatements in the financial statements. This limits trial lawyers from suing for unlimited damages and probably puts them out of business. Insurance companies keep cash on hand to pay out damages should they occur, but management is personally on the hook for a portion of those damages as well (say 10%), incentivizing them to keep the books clean. And finally, one can do a real cost-benefit analysis of when it makes sense to implement new systems controls in vs paying a higher premium in your insurance policy, unlike the current system (under Sarbanes Oxley) in which you must maintain perfect controls no matter what the cost.

I am ambivalent as to whether or not existing insurance companies entered this new business thus hiring the current audit firms to just check regulatory compliance, or whether the current audit firms transformed themselves into insurance companies. But the current system is too costly with too many mis-aligned incentives to remain.

An alternative way to mitigate against collusion between auditors and management that is simpler and likely easier to pass is to require all public companies to change audit firms every 5 years, and perhaps having auditors chosen for publicly traded companies by the exchange, rather than by management. This won’t stop any such collusion within said 5 year time frame, but it would force more auditors to look at a company’s books skeptically when audit firms are changed. Audit firms already do this internally, rotating partners on major accounts every 5 years, but they’re motivated to cover for each other as they are all connected in the same partnership. Rotating actual firms will force questionable accounting practices to light, and do far more to mitigate against what caused Enron to happen than anything in the existing Sarbanes-Oxley law does now.

Fix Financial Reporting

Financial statement reporting and the rules that govern them have completely gone off the rails. In the years that I’ve been working (I graduated from college in 1993 for reference), financial statements have gone from being something that management and investors read, used and looked forward to receiving to something that everyone ignores. Nobody uses them for a few reasons:

  1. Complexity: Accounting rules have gotten to be inordinately complex, with footnotes stretching as far as the eye can see. Complexity benefits people who work in the audit industry, who need to assure one’s compliance with said complexity and therefore profit from it, but it benefits no one else. Excessive complexity by definition detracts from transparency as well, and therefore serves the interests of neither management nor investors.
  2. Cash Isn’t King: Cash is king to those who make business decisions, but accruals are king to the FASB and those who enforce accounting regulations. This means that the financial statements continue to get cluttered up with non-cash related numbers that management and investors need to adjust to get at what’s really going on.
  3. Spaghetti Code: American accounting rules are set by the FASB which, in an attempt to stop any and all forms of accounting manipulations possible, has set up a spaghetti code set of specific rules that become increasingly impossible to comply with. Unlike in Europe, where principles are set forth that are to be complied with using professional judgment, in the United States, every possible scenario is expected to be regulated. Thankfully, the United States is moving over to international accounting standards in the coming years, which should help to alleviate this problem.
  4. Relevancy: The FASB is made up of academics from the audit industry, and as academics, they are counting angels on pin heads while ignoring real needs in the marketplace. The principle financial measure that investors (and management) look for in managing a company is what’s called “Free Cash Flow”. Yet there is nowhere in a set of financial statements where one can find a pure Free Cash Flow number, nor is there a standard method of calculating Free Cash Flow stated anywhere in the accounting regulations.

There is a simple solution here. First off, minimize accounting rules that don’t relate to cash items. That goes for anything involving amortization or depreciation, or other oddities such as stock option compensation expense. Second, put a statement of Free Cash Flows in the financial statements, and make sound rules around how to pull one together. Don’t make investors fish through the Statement of Cash Flows and the footnotes to try to pull Free Cash Flows Together. And third, dismantle the FASB and adopt the European approach to using broad principles for accounting standards, drawing o both academics and those with expertise in industry to continue to maintain the accounting rules. Thankfully, it looks like this last part may be coming to pass already.

Corporate Board Reform

Corporate boards, in public companies at any rate, are far too often the friends and family of the chairman, even when the company isn’t majority family owned or closely held outside the trading shares. This is problematic in that these cronies of the company president rubber stamp everything he does, and do not do an adequate job of supervising the activities of management.

There is a simple solution here. First, force disclosure of any ties board members have or have had with each other or with management previously, e.g. “Mr. Smith was a coworker of the chairman at Company X from 1997-2002.” Second, force board members to invest a significant amount of their personal net work into the stock of the company they are overseeing, like 5%. This will align their interests with those of shareholders. And finally, do not let them divest their holdings until say 3 years after they leave the board. This ensures that what they are doing is in the long term interests of shareholders, and is not a short term stunt to suck value out of the company.

Yes, these requirements will make it more difficult to find board members, but that should exactly be the point. Board members shouldn’t serve on the boards of multiple companies where they can’t possibly devote enough energy to overseeing what’s going on. And it will require more individuals to be board members, rather than every CEO serving on other company’s boards in act of reciprocal cronyism.

I want to emphasize that these rules are unnecessary in privately held companies, where shareholders already can influence company management more directly.

Market Regulations:

Re-engineer the SEC

After the whole Bernie Madoff Ponzi scheme broke, I happened to catch an interview with Judge Judy on the television (Larry King I believe). She characterized the SEC’s failure as one of “failing to followup on leads.” Judge Judy is an intelligent woman, yet her characterization was fantastically wrong. It’s a characterization I’ve seen elsewhere too, so it needs to be addressed.

There was no “lead” that he SEC failed to follow up on. It is not like a murder investigation, where some piece of evidence was forgotten in the house and thus the police failed to crack the case. In this instance, the SEC literally didn’t know that a murder had occurred. Madoff hadn’t failed to file paperwork, or done so in a manner that would have or should have raised any red flags. Rather, what happened was that Markopolos, a quant trader who tried to reverse-engineer Madoff’s trading strategy, mathematically proved that Madoff was a fraud and informed the SEC, yet the SEC failed to act. The question is why?

Markopolos proved that Madoff was a fraud mathematically. It wasn’t as if he has some sort of documentary evidence that Madoff was cheating his customers. He didn’t. Rather, he proved using statistics that Madoff’s fund couldn’t be anything other than a Ponzi scheme. So why didn’t the SEC act on it?

Because the SEC is staffed with lawyers rather than mathematicians.

What this meant was that Markopolos was speaking Greek to the SEC (no pun intended), and they couldn’t understand what he was telling them.

In fact, the whole way the SEC is set up is wrong. Currently, the SEC is staffed with lawyers who aspire to work for the Wall Street firms they regulate. That alone is a recipe for disaster. But as we can see from the Madoff example, regulatory compliance isn’t the issue. Most firms, even ones perpetuating fraud, comply with reporting regulations.

In fact, regulatory compliance is best performed by existing audit firms (hired by insurance companies or the exchange, as earlier discussed). Privatizing this function makes a world of sense, as insuring compliance isn’t that difficult a job in the first place. In fact, the way it’s currently performed feels more like a government make-work program than an effective regulatory method.

Consider any website that hosts user-contributed content, like flickr or YouTube. Each of these sites are basically user policed. When someone uploads something inappropriate, pornography or copyrighted material, users flag it for review, and management eventually reviews and determines if the content needs to be removed. That’s the way it should work. But imagine if everything needed to be approved before it went up? That would require a legion of reviewers and would be cumbersome for the preponderance of uploaders, who are trying to play by the rules. It would like the Apple app store, or our current SEC.

Reporting compliance should be outsourced to each company’s audit firm (assurance or insurance). There is no need for the SEC to review any company’s filings before they are made public. Instead, there should be a flagging system for financial report users to request intervention on problematic filings. Flags would be prioritized based on the credibility of the flagger and the size of the problem. A mutual fund manager saying something appears fraudulent would take precedence over a blogger who found a typo. Doing this would enable the SEC to cut back on its legal staff and bulk up on what it needs, an actuarial and mathematical staff.

We need to hire a specific math group at the SEC, staffed by people with real industry experience. In fact, it’s what ought to be the bulk of the SEC investigation group. What they need to do is scour the market for mathematical improbabilities and statistical anomalies. When a guy like Madoff is reporting impossible returns, they discover it and launch an investigation.

Currently, major Wall Street Firms employ math PhDs to write algorithms to scour the market for opportunities to exploit. I say we hire the same PhDs, at the same rates if necessary, to scour the market for fraud. There is no reason why it can’t be done. And it would be a far more productive use of our money that paying SEC lawyers to argue over phraseology in 10-Ks as they currently do now. That adds value for nobody.

Revise Insider Trading And Related Rules

The intent of insider trading prohibitions is to eliminate or at best reduce incidents of people benefiting from asymmetrical information. There are basically two different types of insider trading that goes on, each of which I will address separately: insider trading by those inside a publicly traded company, and from those who are outside said company.

When a manager buys stock in his own company in advance of good news being released, who does that harm? Arguably, the seller of the stock management bought would like to have known the good news that the manager knows, but so what? If he needs to sell he needs to sell. Management, on the other hand, is being properly incentivized to add value to the company. So long as they disclose who they are when engaging in the purchase, the market can make any inferences from the purchase that they will. One should not fear that this incentivizes management to lie, as there are already audit procedures in place to protect against that. No, allowing management to buy stock in advance of good news being released may not be fair, but you can never eliminate asymmetrical information. In fact in this instance, it is better to give management incentive to make good things happen for the company than it is to attempt to eliminate asymmetrical information from the market.

Selling stock is another matter completely. Selling stock in advance of bad news being released to the market gives management an advantage when they have mismanaged the company. That is bad for shareholders. Management should not be allowed to profit for mismanagement. Therefore, a simple statement made at the time of the sale stating the reasons for the sale is all that is required. If management sells stock in advance of an adverse event being announced without disclosing said event in management’s statement, then penalties would be applied. I am open as to the specifics regarding what qualifies as such an event, and how long from the sale date it is disclosed. This is different from current practices, in that management announces they are making the sale well in advance of doing so, and commits to making the sale regardless of what the market is doing at that time. There is no reason to deprive managers from cashing out when times are good should they need to do so for personal reasons.

I should also add that there are currently rules prohibiting management from selling out at the time of an IPO. That rule, in particular, is beyond stupid. Entrepreneurs who toiled to get their stock to an IPO should not be prevented from cashing out a portion of their stock at a liquidity event. Moreover, managers should be incentivized to get the highest price possible for the stock at an IPO to best fund the company and get the highest value for the remaining shareholders. By forbidding managers from selling out at the IPO, you remove that incentive for him to do those things. In fact, if anything, a manager should be forced to sell a portion of his stock at the time of an IPO, to properly align incentives.

Again, ostensibly the reason for forbidding managers from selling stock at the time of an IPO is to prevent fraudulent IPOs. But current audit practices prevent that more than adequately. The current setup, however, encourages shenanigans. I’ll quote myself from May 2003:

So what does this have to do with IPO’s? It has to do with an SEC rule called a ‘lockup’ period. What that means is that for 180 days after an IPO (and some other types of transactions too, like a sale of a company), the management of the company cannot trade their shares on the stock market. In other words, on IPO day, all the shareholders get rich except for the founders and management that got them to the point of IPO.

So think about it. Management, working with investment bankers, spends all this energy determining what the right time is for an IPO, but then cannot benefit from the work themselves. Instead, they must wait for 6 months, when the market may be entirely different than what it is at the time of the IPO. This is manifestly unfair. The ostensible reason for it is to discourage management from taking public companies that have no longevity (boy, that sure worked well in the 90?s, huh?). What in fact happens, is something much different. Imagine this conversation between the CEO of a company about to go public and his banker:

CEO: This is awful. I’ve worked so hard for this long and now I have to wait six months before I can cash out some of my stock too. It’s unfair. Who knows what the market will look like then?

Banker: I hear you. I hear it all the time. I may be able to help?

CEO: Help, but how?

Banker: Well, see, just lower your offering price on the IPO a bit, say 15%? don’t worry, the SEC will just think we’re being conservative? Then, allow me to allocate all the initial shares offered to the public. I have five other companies who are doing the same thing. So while you can’t sell your own stock for 6 months, I’ll give you the opportunity to sell someone else’s stock at a discounted value by allocating their shares to you, to get in on their IPO so to speak. All you have to do is lower your stock price just a bit, so that the rest of us can benefit from the ‘pop’ you’ll receive on the day you go public.

CEO: It’s a deal!

See what just happened? The banker acts as a broker between the managers of different companies, facilitating the transaction that would not have happened were it not for the SEC regulations. Just like getting a bonus for washing the fire trucks. Furthermore, the process has become more muddied, less transparent, and has damaged the ordinary shareholder far more than it would had without the regulation. Now, the average shareholder doesn’t know how much stock management decided to cash out from at IPO time, and is having his stock sold at less than market value with no discernable benefit to him. Furthermore, every time one of these ‘pops’ occurs, the average investor gets jubilant. He develops a psychology whereby he believes that if he can just buy in early enough he can’t lose. So now stocks aren’t just popping 15% or so on IPO day. They’re popping 600% or more. And the banker needs more and more IPOs to feed his pipeline, while companies are more than willing to go public even when they’re not ready, because they know they can cash out right away without anyone really knowing. So the bankers (like Quattrone) benefit while the average Joe gets screwed. Way to go SEC.

So let’s wrap by seeing what would happen in a world without lockups. Management is no longer incentivized to price company stock artificially low, thus no more pops on IPO day. And with no more pops, there’s no more extreme exuberance either. And shareholders can see for themselves if management is dumping company stock, which speaks volumes about what management really thinks of their company. No more under the table freebies from bankers either, as their motive for giving them disappears.

Damn I’m good.

I should point out that the above exchange is already illegal, but that’s not to say it doesn’t happen or didn’t happen rather commonly during the Dot Com boom.

So let’s turn to the other side of the equation, when traders engage in insider trading. again, there are two versions of this, buying or selling on confidential company information, and doing so based on confidential trading strategies. The first should be illegal. If information from inside the company is to be released, it should be released to everyone. There is no incentive to good manage well by allowing cronies of senior management trade on insider information.

The second piece isn’t insider trading specifically, but involves disclosure rules about accumulating more than 5% of a company, and when you have to announce your intentions to buy out a company. Parties should be allowed to collude to accumulate stock without announcing themselves. This is no different than how Walt Disney bought all the land that eventually became Walt Disney World. But rules designed to stop this kind of collusion only serve to entrench incompetent management. Same for poison pill type laws. Stopping acquisition activity, hostile or otherwise impedes capital flows, which is the opposite of our goals here. So open the floodgates and let management be rewarded for good efforts and punished for poor performance.

There is one practice that appears to have been going on that does need to be stopped however. Namely, using analyst reports and crony newspaper reporters to drive down the price of a stock temporarily so that short sellers can benefit. That amounts to a type of slander by the reporters and theft by the short sellers and those activities should be prosecuted as such. I would even support a law enabling shareholders to sue reporters and analysts who publish false or poorly sourced information even without a connection to short sellers being proven. There’s just too many antics going on with business reporting right now, and it needs to be cleaned up.

Enforce Settlement

Counterfeiting stock is and should be, always illegal. There is no circumstance for counterfeiting stock and selling it on the open market, even if you intend to buy it back at some future date. Naked short selling is when someone electronically counterfeits stock, sells it on the open market to someone who doesn’t realize it’s counterfeit, thus driving down the price. Done in enough volumes, the stock price can collapse causing the stock to be de-listed, forcing the company into default on it’s debt covenants after which point it folds.

This is a criminal activity that played no small role in the financial crisis that we have just witnessed. The website Deep Capture has done an excellent job of documenting and reporting on the phenomenon, and I would strongly suggest you read through their site. Suffice it to say, naked short selling is and ought to be a crime.

Unfortunately, the SEC has chosen not to enforce laws regarding naked short selling as of late. As a result, many people have lost confidence in the markets, and this benefits only the short-sellers. What’s worse is the SEC requires a list be published of companies for whom significantly more shares are trading than have been issued, yet the SEC refuses to publish who it is that is selling these shares. It’s criminal. The SEC needs to immediately prosecute those firms who are selling counterfeit shares and force them to buy them back on the open market. People need to go to jail over this. There is just no two ways about it.

Finally, settlement of all trades must happen within 24 hours, no exceptions. Unsettled trades which accumulate to equal more than 1% of a company’s outstanding shares need to result in trading being halted in the shares and the names of those who have sold more stock than they own made public. While I normally would call for respecting the privacy of those who trade stock, I have no respect for those who are in effect counterfeiting shares. So when that happens, a full and public investigation is immediately necessary.

The pre-borrowing rule is a good start, but does not negate the need to expose naked short selling when it is occurring.

Systemic Risk in Banking

So it would appear that we have a problem with systemic risk in the banking industry. And while adopting my housing reforms and eliminating naked short selling will do more to eliminate systemic risk than anything described here will, there are a few things that ought to be said still.

First up is the fact that if a bank really is too big to fail, then it should be broken up by anti-trust statute before anything bad happens. Not that I really believe that any bank is too big to fail. But if we as a country are going to bail our banks above a certain size when they screw up, they they will ALWAYS screw up eventually, because of the moral hazard involved. Better to break up those larger banks into smaller banks first, than have to bail them out later.

Secondly, the best way to ensure that no bank gets too big to fail is to increase the degree of competition in the sector. For years now, retail establishments such as Walmart have wanted to be able to open bank branches of their own within their stores, just like they have pharmacies. Federal laws prevent this. But to my mind a retail establishment should be good at retail of all kinds, including basic depository banking. And Walmart would provide real competition to existing banks, drawing customers away from them, creating more diversity in the marketplace. And diversity in the marketplace, i.e. more players, is what increases redundancy and reduces systemic risk. So why not do it already?

I should also mention that it appears as if the Obama administration wants to attempt to reduce systemic risk by having increasing central authority in the Federal Reserve. This will, of course, have the opposite effect as any mistake made by the central authority itself will generate more systemic risk than any one large bank’s mistakes possibly could. The Obama administration also seems to think that Venture Capital represents a systemic risk, a claim too silly to take seriously. Finally, they seem to want to force private equity firms to open their books to the public, a move which seems designed to pry open proprietary trading strategies, and seems to be more about nosiness and probably spawning tax generation ideas than anything else. Again, dumping reporting or other types of regulation on private equity will do nothing to reduce systemic risk. Far better to go after naked short selling as described above and expose it when it happens. Forcing hedge funds who do legitimate trading to disclose proprietary trading strategies will just put them out of business.

I should point out that while I do have thoughts on monetary policy and the Federal Reserve, they are the subject of another chapter in the Grand Plan.

I should point out in conclusion that the Obama administration has a number of other reforms that have nothing to do with the aforementioned parts of the Grand Plan. ReasonTV does an adequate job of addressing them. Suffice it to say that their “reforms” have little to do with fixing the systemic problems that created our current mess, and if anything are harmful to the operation of the markets. But as the Grand Plan is for me to express my own views and not attempt to refute every other plan that is out there, I’ll leave it to others to address his plans, and to the viewer to choose whether or not to consider them.

I should note that monetary policy will be discussed in a later chapter of teh Grand Plan.

I want to thank Neil Gordon for reviewing this for me prior to its publication.

Postscript: It looks like Obama is going to reveal his own version of finance regulatory reform on Monday. Should be interesting to see how he matches up against what I’ve proposed here.

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