The New Book On Regulation I Just Decided To Write: Blame It On Monaco

This is the third article in a series of columns devoted to financial regulation prompted by the comments of a Swiss academic at the XII^th Annual CIFA Forum in Monaco. (See first here and second here.)

Having spent 20 years as a non-academic professional, I still find it odd the directions in which a single speaker or writer can start an academic on a convoluted path of research that spans multiple disciplines and eras and produces a series of “light bulb” analytical moments. And that prompts a digression into a symptom of the problem illuminated by that series of moments that has led me to decide to write a book on regulation.

A Digression on Brooks, Greed, Curiosity, Academics, and Regulators

In David Brooks’ April 11, 2014 column, Brooks tells us that Michael Lewis’ most recent book about high frequency trading (HFT) abuses is “really a morality tale.”

“It’s nominally a book about finance, but it’s really a morality tale. The core question Lewis forces us to ask is: Why did some people do the right thing while most of their peers did not?”

Brooks claims that the reason only a few people in finance act morally is that so many of them are focused exclusively on making money that only a few of them are curious.

“The answer, I think, is that most people on Wall Street are primarily motivated to make money, but a few people are primarily motivated by an intense desire to figure stuff out.”

Brooks explains why curiosity is a wonderful thing.

“Most of us have at one time or another felt ourselves in the grip of the explanatory drive. You’re confronted by some puzzle, confusion or mystery. Your inability to come up with an answer gnaws at you. You’re up at night, turning the problem over in your mind. Then, suddenly: clarity. The pieces click into place. There’s a jolt of pure satisfaction.”

The “profit motive” (which Brooks will soon call “greed”) is an insuperable barrier to curiosity and “knowledge.” Only a tiny group of people with the “intrinsic desire” for knowledge can triumph over their immoral peers.

“Knowledge is the deeper understanding of how things work. It’s obtained only by long and inefficient study. It’s gained by those who set aside the profit motive and instead possess an intrinsic desire just to know.

The heroes of Lewis’s book have this intrinsic desire.”

Brooks then claims that this rare passion (“love”) for knowledge that motivates this literal handful of financiers also inoculates them from immorality and predisposes them to be driven to “fairness.”

“If everybody is just chasing material self-interest, the invisible hand won’t lead to well-functioning markets. It will just lead to arrangements in which market insiders take advantage of everybody else. Capitalism requires the full range of motivation, including the intrinsic drive for knowledge and fairness.

Second, you can’t tame the desire for money with sermons. You can only counteract greed with some superior love, like the love of knowledge.”

Yes, Brooks has recirculated the concept that a handful of “philosopher kings” are all that stands between us and moral ruin (plus endemic financial fraud and recurrent crises). Regulators, of course, are not eligible to be part of this elect.

“[I]f market-rigging is defeated, it won’t be by government regulators. It will be through a market innovation in which a good exchange replaces bad exchanges, designed by those who fundamentally understood the old system.”

As I have warned repeatedly, anyone who uses military metaphors that assert that fraud can be “defeated” in any field for eternity is sure to be peddling snake oil. But my question is why Brooks thinks he can get away with simply asserting as if it were a fact that regulators are incapable of curiosity and never have a “jolt of pure satisfaction?” Why does he think academics aren’t even worthy of his back-of-the-hand dismissal of regulators? Why does he think elite white-collar financial frauds aren’t curious and don’t get a “jolt of satisfaction” when they figure out how to suborn an employee and turn the “market innovation” that “defeated” “market-rigging” into an optimal means of “market rigging” that thrives on the philosopher kings’ complacency.

We Know Why the CEOs Leading Control Frauds Fear Regulators and Prosecutors

There’s no mystery why Charles Keating ordered his thug to make his “Highest Priority” the effort to “GET BLACK … KILL HIM DEAD” (all caps in original). He viewed us as the regulatory cops on the beat that could stop his fraud schemes, recover any remaining proceeds, and imprison him. There’s also no question but that Keating viewed us as having vastly too much curiosity, dedication, and competence and too little greed for his liking. Theoclassical economists have mounted an unholy war to discredit and intimidate regulation and regulators – and to replace them with anti-regulators – for over a century, as Nomi Klein documents in All The Presidents’ Bankers.

In the recent crisis, Clinton and Bush appointed anti-regulators who created a self-fulfilling prophecy of “regulatory failure.” It would be absurd to infer from such a planned failure that regulation must fail. If you had let me appoint Charles Keating to run any corporation in the world the result would have been a catastrophic failure – that does not mean that private ownership must fail. Clinton and Bush ran financial regulation by appointing the equivalents of Vidkun Quisling as our anti-regulatory leaders.

The mystery is why progressives, moderates, and conservatives have given up on regulation and regulators. Classical economists – and Ayn Rand, von Mises, and von Hayek – agreed that the government should prohibit and prosecute fraud. The consequences for honest business people of failing to prevent widespread fraud are often disastrous because it can create a “Gresham’s” dynamic in which bad ethics drives good ethics from the markets and professions. Our paramount job as financial regulators is to seek to detect and sanction elite control frauds so that we prevent such a Gresham’s dynamic by preventing cheaters from gaining a competitive advantage. George Akerlof explained the dynamic in his classic 1970 article on markets for “lemons” (often an example of an anti-purchaser control fraud).

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence” (Akerlof 1970).

Non-economists have observed the Gresham’s dynamic long before Akerlof’s article.