Regulatory Discretion Does Not Work
As usual when regulators try to block conflicts of interest they just create a crisis of competence.
Of course investment advisors sell products in which they have a proprietary interest. Mostly it does not matter because it’s all plain vanilla stuff and the advisors know about as much as you can pick up in less expensive correspondence course. But actually useful advisors are good because they either develop their own investment solutions and use the advisor business as a way of retailing them or are skilled selectors of other managers. Thus treating proprietary solutions as a conflict of interest is just a way of enforcing mediocrity, already overabundant in this business.
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If Pearlstein’s source is right that “strict resolution” would expose counterparties to significant losses, then it would be too strict to protect credit markets.
“Counterparty” is to some extent a term of art, but it certainly includes investors who leave securities they actually own at their brokers’, for instance as collateral against margin loans. If counterparties are at risk for losing that collateral in a bankruptcy enforced on their broker by he regulatory authority, then the result will be far from an “orderly” resolution. The treatment of counterparties was the most important difference between the Bear and Lehman resolutions; it was leaving Lehman counterparties twisting in the wind that precipitated Black September.
So either the new resolution authority would not be able to orchestrate orderly shut downs of imperiled institutions, or it would have to make up the rules as it went along, preserving counterparties even though it is not supposed to. That would leave us right back where we started, with no one knowing what the government will do in the event of a too-big-to-fail institution failing.
Regulatory discretion does not work. We need credible rules for what government will do, including possibly a rule that says government will do nothing, so that whatever the rules are, markets can act accordingly.
Tags: Andrew Redleaf, Regulation, Richard Vigilante, Whitebox
