By John Kemp
LONDON Nov 23 (Reuters) - Bank of England Financial Policy Committee Member Robert Jenkins, speaking on Tuesday, blasted the banking and financial services industry for supporting a "lobbying strategy that exploits misunderstanding and fear" to defeat reform.
His criticism is timely and well-aimed. After the biggest financial crisis in 70 years, the financial system remains dysfunctional, with little in the way of real reform. Lobbyists and lawyers for the industry must shoulder much of the blame.
Even those changes that have been agreed are being delayed by trench warfare, as lobbyists and lawyers fight to water them down during the detailed rulemaking and implementation process.
The partial privatisation of policymaking, and the outsized influence wielded by organisations such as the British Bankers Association, Institute of International Finance, International Swaps and Derivatives Association, and the Securities Industry and Financial Markets Association was a contributing factor to the financial crisis, and now risks blocking efforts to remake the industry on a more sensible basis.
INTEGRITY, FAIRNESS, RESOLVE
"Lobbies are there to lobby" and that will not change, Jenkins acknowledged in a hard-hitting speech revealing frustration among policymakers that the industry is blocking any and all efforts at reform -- from bank capital, proprietary trading, regulation of derivatives, and position limits in commodity markets. ()
But their influence must be diminished. The first step is to recognise that trade associations represent the private interests of their members rather than the public interest. While they have a valuable role to play articulating points of view, and are often repositories of useful technical expertise, their advice should never be taken as disinterested.
The second, more important, step is to build up the capacity of regulators to make their own assessments and reach their own view of the risks and challenges facing the industry, and the likely consequences of various policy options, reducing their over-reliance on trade associations for technical advice.
The third requirement is for politicians -- and in the United States, the courts -- to show more deference to regulators when they try to find the balance between leaving markets to regulate themselves and interventions designed to safeguard financial stability and other public interests.
Regulators must remain accountable. But in too many instances, efforts to craft modest regulations have been hamstrung by political lobbying or legal challenges.
THE RHETORIC OF REACTION
If voters wonder why nothing has changed, a big part of the answer lies in the influence wielded by well-funded lobbyists and lawyers employing Albert Hirschman's three arguments (perversity, futility and jeopardy) to defend the status quo.
Hirschman showed that opponents usually resort to these arguments to defeat reform: reforms will have the opposite effect to the one intended; they won't work anyway; and they will jeopardise other desirable goals ("The Rhetoric of Reaction: Perversity, Futility, Jeopardy", 1991).
In financial regulation, examples of this type of lobbying are legion. According to the industry, demanding banks raise capital will only expose their present weakness (perversity); lead to the migration of banking activity to less heavily regulated jurisdictions (futility); and cut credit to households and firms in the real economy (jeopardy).
Imposing position limits in commodity markets will cut liquidity and increase volatility (perversity); cause big investors to shift into physical markets and less regulated exchanges (futility); and make it harder for commercial users to hedge inventories and purchases (jeopardy).
Jenkins ended his remarks with a call for banking leaders to distance themselves from the lobbying effort and show more leadership. It is a noble idea, but doomed to failure. Bank leaders are there to advance the interests of their shareholders and employees. Resistance to regulation is in their DNA.
Regulation is most needed when externalities and other market failures exist which mean self-interested institutions do not behave in a socially optimal way. These are precisely the circumstances in which rational bank leaders will resist attempts at regulation hardest.
In most cases, calculated resistance to regulation is overlaid with emotional hostility to an "over-mighty state" and a preference for "free markets". So Jenkins' call for bank leaders to "lobby less and lead a lot more" underestimates the scale of the problem.
It would be nice to think that bank leaders might revert to being "long-term greedy", to cite the old motto of Goldman Sachs. But Jenkins was speaking at an event examining the issue of short-termism, so former Citigroup chief executive Charles Prince's comments about needing to carry on dancing while the music is playing are more appropriate.
It is also hopeless to expect lobbyists and industry lawyers to reform themselves. They are paid advocates for the interests of their clients. The banking industry has the most money, so it comes as no surprise it has the best and most articulate lobbyists and lawyers.
The relationship is symbiotic. Banks and financial services firms have become one of the most important sources of revenues and growth for lobbying firms and the legal industry.
EVISCERATION OF THE STATE
If policymakers genuinely want better and more effective financial regulation, the crucial step is to build technical expertise within the public sector to reduce its reliance on specialist lawyers and trade associations for advice.
In too many instances, agencies lack expertise, personnel and quality supervisory staff to craft and implement regulations effectively. And when they do occasionally try to impose tough rules, they lack backing from politicians and the courts.
In a previous column about "The slow death of the regulatory state" I suggested the capacity to act as economic and industry regulator had withered away ():
"On paper, regulators (the Federal Reserve, Mine Safety Administration, and Minerals Management Service) wielded immense power to enforce rules on health and safety and risk-taking. But in practice they subcontracted enforcement and even the rule-writing to the firms they were supposed to be overseeing ...
"Regulatory capture -- where regulators come to share the interests and viewpoint of the industry they are supposed to be overseeing, rather than acting in the broader "public interest" -- is nothing new. President Dwight Eisenhower warned about the power of the military-industrial complex in 1961.
"But the scale of the capture across so many agencies, reaching into the heart of the regulatory state, under governments of all colours, is unprecedented in modern times."
In too many instances, governments have subcontracted rule-writing and enforcement to trade associations and specialist lawyers. There was an assumption that private self-interest would ensure socially desirable outcomes through "market discipline". But in practice it has resulted in a disastrous co-mingling of public regulation and private interest that has given rise to rent-seeking behaviour -- manipulating the regulatory environment rather than adding genuine value.
MORE REGULATORY CAPACITY
Trade associations and exchanges cannot usually combine promotion of their members' interests with public policy functions and regulation; the two should be more separated in future.
The proper role for regulators is to listen to representations and concerns from all the affected parties to a decision, assimilate them and then reach their own, independent and carefully thought-through position -- much like a judge in a legal case. In fact much regulatory activity is described as "quasi-judicial".
The earlier column outlined various reasons for the evisceration of regulation: the intellectual ascendancy of pro-market philosophy since the 1970s, the conservative judicial revolution in the United States, and the increasing complexity of financial markets.
It is unclear how far the pendulum has started to swing back. Most observers remain sceptical about the prospects for real change.
But if Jenkins and his colleagues want better regulation and more "integrity and prudence", they would be wise to build up their own capacity rather than wait for bankers, lobbyists and lawyers to undergo a Damascene conversion.