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March 29th, 2016

The Visible Hand

The Visible Hand is increasingly seen in all corners of domestic commerce. Few object to the presence of the visible hand as a necessary cop on the beat to give all parties a sense both that rules apply and that there is a monitor. Commercial difficulties mount: 1) when the monitor is not responsive, 2) when there is no real oversight of the monitor, making them a czar that is not at risk for its decisions and 3) when the rulemaking becomes so micro and complex that it can neither be thoughtful nor fair. Many of these schemes become so Rube Goldberg in their nature that proposing them outside of government as a plot for a novel would result in rejection by a publisher as not being credible.

In the 1920’s Senator Charles Dawes chaired a committee charged with sorting out the financial chaos created by World War I and the Versailles Treaty. Britain and France were deeply in debt to the U.S. for borrowings incurred to fund their war efforts. Germany was deeply in debt due to the reparations they were required, by the Versailles Treaty, to pay Britain and France. The Dawes Plan had the U.S. provide new loans to Germany, so they could pay France and Britain who could use this money to pay the U.S. How could this plan not succeed? Dawes was given a Nobel Peace Prize for the creation of the 7% Dawes Loan bonds. In 1930 they traded at 109. In 1934, 35% of the loans were in default when Germany announced they would no longer pay on Dawes bonds. Dawes Loans was one of the earlier monitor over- reaches in our history.

A brief look across the business landscape reminds one how similar the commercial experience with a regulator is becoming to a trip to any state’s motor vehicle department where one has no choice but to comply with arcane, contradictory rules with no explanation or simply be denied the privilege of driving. J.P. Morgan, GE, Citi and UBS paid billions to settle with the Federal Housing Finance Agency for loans sold to Fannie Mae and Freddie Mac. Yet, neither the statements from the bank nor the regulators indicated what the firms had done wrong nor contained an admission of guilt by the firms. This is not to suggest that banks are blameless, but one is left with a feeling that the monitor capriciously could have said, “pay us or lose your banking license.” There is no sense justice was done as the only public image is that of a regulator proclaiming a victory. Seeing this settlement, a Chairman of an international bank anonymously told the Economist “it would be suicide to fight them.” Bear Stearns was forced into JPM’s arms over a weekend by regulators who did not want a failed investment bank on their hands. Subsequently, fining JPM $5.1 Billion for loans sold by Bear Stearns to Fannie Mae (see above), creates a very real public policy question: “to whom will the government turn to buy the next failed bank if a multi-billion dollar fine is the reward for doing the government a favor?”

At a much more pedestrian level the examples of regulatory tripwires are copious. The USDA manual and memos for high school cafeterias run 4700 pages as the monitor attempts to manage school children’s diets down to the calorie and salt content levels. This has actually led to students bringing their own salt shakers to school and being disciplined for doing so. Banks have had to hire thousands of workers and to spend billions of dollars on compliance and procedures where simply limiting their leverage and sphere of business would have made the system safer. Approval for such small matters, as small as a change in box labeling on a generic drug, now take years of multiple reviews at the FDA. If a company is in disagreement with or is harmed by an agency’s process or investigation their remedy is usually an administrative proceeding where the federal agency serves as prosecutor, judge and jury. In a process reminiscent of the Dawes Plan, the government will subsidize a Tesla purchase with $20,000 of credits, up to $45,000 in California, to encourage use of electric cars as a way of reducing our dependence on fossil fuels. Yet, the electricity to run a Tesla is largely produced by fossil fuels. Consequently, the monitor is paying a consumer up to $45,000 to consume fossil fuels differently, not less. These burdens do not fall solely on the companies as the costs of review and the delay increases the costs of products to consumers. The simple act of making agencies and their employees accountable for its actions or inaction would be a sizeable stimulant. In reviewing investments the ability of regulators to retard new product development and to influence existing business is a critical due diligence area. An infusion of common sense and agency responsibility into the regulatory process is likely to lead to better economic growth and better regulation.

I’m Rob Morris and I approved this blog.

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