The ethical deal

The ethical deal

Should financial products be regulated like medicines?

The New York Times columnist, Gretchen Morgenson, has plucked from academic obscurity an academic paper calling for the establishment of a new federal agency to determine whether financial products are deemed safe.

The paper, written by Eric Posner and E. Glen Weyl, argues that the dangers financial instruments are ‘at least as extreme as the dangers of medicines.’ As a consequence, they suggest, an independent agency should have the capacity and mandate to judge social utility in advance.

The goal is not to protect gullible investors, be they sophisticated or not, but rather to reduce systemic risk by deterring speculation that could cause systemic risk.

It is a laudable but fiendishly complex task. On what basis can a product be deemed dangerous and on what basis? How could such an agency evade the endemic capture problems endemic in the regulation of financial services? This is not to say it is without merit.

Advancing a social utility goal would fundamentally change the operational parameters of financial capitalism and its reliance on regulation through disclosure.

Ms Morgensen concedes, however, that this initiative is highly unlikely to gain traction anytime soon.

If all this sounds depressingly familiar it is.

Readers may recall that Professor Elizabeth Warren of Harvard had proposed the establishment of a Financial Product Safety Commission in 2008.

Her proposals received limited traction with (sections of) Congress and the Obama administration. The Wall Street Reform and Investor Protection Act (2010) established a Consumer Financial Protection Agency. President Obama selected Professor Warren as interim chairman but passed her over for the permanent position in large part because of a concerted campaign against her by lobbyists serving Wall Street interests. She is now advancing her stalled agenda by campaigning for a Senate seat in Massachusetts.

There has been considerable opposition to any proposal to limit the access of sophisticated investors to complex financial products. Whether such a distinction is warranted given institutional investor losses across the globe is another matter entirely, a point now being made by professors within the intellectual fortress that legitimated the deregulation agenda that got us into this mess in the first place.

There are three problems with the proposed alternative regulatory structure. First, it creates the erroneous impression that an all-seeing regulator, removed from her fray, can adjudicate impartially, with its findings accepted without question. The FDA is not the Supreme Court. It is as susceptible to political pressure as the SEC. Second, it does not deal with the real problem, which is the lack of restraint inside the firm itself. Third, there is no evidence of political will to reopen the Pandora’s Box of regulatory purpose.

For further details, see http://www.clmr.unsw.edu.au