Regulating Pendulums

How much regulation do the banks need?

The Dodd-Frank bill has been around for a year now, and it’s reasonable to ask if anything has changed. The logic behind Dodd-Frank is simple: our capitalist system runs on self-interest and profits. Regulation is necessary to make sure things stay within reasonable limits—things like systemic risk, concentration of power, and prevention of fraud. If professional ethics, self-regulation, and a sense of limits could be counted on, we wouldn’t need formal laws. Sadly, they can’t.

But regulators are human and regulations are crafted by imperfect people. It’s easy to write hard-and-fast rules, but entrepreneurs are all about innovation; regulation often seems to be fighting the last war. Strict rules become outdated and get circumvented. And the proof is in the pudding: the regulated banks were ground-zero for the last crisis; the unregulated hedge funds largely went unscathed.

Because both free markets and regulation are imperfect systems peopled by imperfect actors, we will never strike a perfect balance. Instead, the pendulum will swing from one tendency to the other. Our financial system will continue to be imperfect, working well 95% of the time for 95% of the people. But it will create large risks the rest of the time.

Money is a societal convention and financial rules will be ever with us. Free markets do the best job of allocating resources; but the ride will always be bumpy.

Douglas R. Tengdin, CFA
Chief Investment Officer
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