REGULATORY MADNESS - WHERE WILL IT END?

More often than not, regulation is a cover-up for exploitation or

protectionism - probably both. Invasive regulation is contagious.

Traders and consumers like to believe that highly regulated markets

serve their best interests, and it suits governments to feel that they

are doing the right thing for their citizens by setting up an elaborate

regulatory system to protect their interests. This knee-jerk response

to every perceived ill has led to a proliferation of regulatory agencies,

causing more confusion than carity.

Coping, for example, with the torrent of financial crimes and

misdemeanours begs the obvious question of which overstretched

regulator should respond to a particular wrongdoing. Financial

Conduct Authority (FCA)? Financial Services Authority (FSA)?

Financial Reporting Council (FRC), now replaced by the Audit,

Reporting and Governance Authority (ARGA)? Prudential Regulatory

Authority (PRA), Competition & Markets Authority (CMA)? I can

hardly keep up!

The scope for overlap between the respective remits of this veritable

alphabet soup of busybodies is legion. Each has its own committees

composed of great and good retired professionals, acting in multiple

arenas of banking, pensions, financial reporting, trading standards,

insurance, mortgage lending - you name it - each covered by its own

ombudsman, with the perennial risk that any particular injustice will

fall through the cracks.

They extract millions in fines and penalties from perceived

wrongdoers - but none of it is applied to compensate the victims.

This continuing charade amounts to little more than an unvarnished

extortion racket by regulatory agencies whose elaborate form masks

their total unfitness for purpose.

The worst currency abuse the world has ever witnessed, the wanton

destruction of purchasing power through programmes of flagrant

money-printing, has been perpetrated by central banks whose

supposed regulatory role should set the standard for the entire

financial sector. Yet those supreme regulators, the Bank of England

and the European Central Bank, have the gall to impose stress tests on commercial banks whose threadbare balance sheets reflect

wounds resulting from central banks' own profligacy.

Let's examine this woeful predicament in a little more detail.

(i) Penalties. Financial penalties levied by regulators at the

corporate level not only fail to compensate victims, but appear to

have little deterrent value as instruments of reform. Why else would

the same charade be repeating itself, over and over?

(i) Findings. Adverse findings and associated penalties have a

negative impact on entities' share prices, thereby inflicting

unwarranted further damage to the savings of innocent shareholders

again, the wrong target.

(ii) Rewarding the reprobates. The reprobates who mastermind

and orchestrate the mis-selling, market rigging -indeed the entire

panoply of inventive violations - are rarely made to suffer personal

retribution for their misdeeds. Concepts of humiliation and

redemption are meaningless to them, as amply evidenced by the

nauseating levels of executive pay that persist

(iv) Auditors of companies that purchase packages of spurious

bonds (however labelled) seem content to vet every aspect of the

transactions - except the current value of what's actually in the

packages. Auditing? Hardly, but they and the masterminds behind the

fudged accounting valuations may weli be members of the same firm.

(v) Bond issuers. The companies issuing those bonds also had

auditors. But when these companies issued paper with arcane titles

(such as "reverse convertibles", or bonds that can be converted into

equity if the issuer can no longer pay the interest; or "collateralised

debt obligations", being parcels of mixed mortgage debts ranked by

"quality", each providing the collateral for the others; and a range of

other "asset-backed securities") their auditors simply closed their

eyes to the impending litigious tempest about to threaten the

solvency of their "clients"

(vi) Regulators. Where are the regulators when dubious accounting

practices are used to contrive Triple A' rating for parcels of near

worthless bonds? Where are they when auditors assess the adequacy

of bondholders' loss provisions using "mark-to-market" criteria?

(vi) Accounting. Accounting rules for loss provisioning require the

"incurred" loss model to be used for valuing debt instruments. This permits the dross to be included in holders' balance sheets at book

value - until they are compelled to face reality and write them off,

perhaps years after the "expected" loss model would have

crystallized those losses. How's that for the corporate version of

kicking the can down the road?

(vii) Government. Government's mindless protection of banks has

corrupted normal market processes of determining executive

remuneration. Left to the market, pay at all levels of management

tends to be higher in the most successful institutions, where wise

executive management is at a premium. But when government

provides guarantees for insurance of deposits, as well as implicit

promises of a bailout if all goes wrong, executive pay is set free of the

market. Ignorance and greed become rampant. When government

and institutions connive in corruption, what hope is there for

effective regulation?

(ix) Citizens. If you throw loans at people, consciences will become

unanchored and immobilised. They will soon become heedless of the

constraint of eventual repayment.

Final thought

All of the above applied at the time of the last financial meltdown, but

that makes it no less (indeed, even more) relevant today. The same

spurious phenomena persist, possibly wearing more inventive cloaks

but incentives for masking dirty deeds are as strong as ever

Of one thing we can be sure - no matter how many regulators are

installed, they may delay, but never prevent the inexorable

implosion.