Simplicity, simplicity, simplicity

Could our financial problems have stemmed from too much complexity?

In banking, there are four or five ways to measure capital and about a dozen ways to classify assets. In insurance there is likewise a complex web of reserve calculations and investment silos. And everyone in finance is subject to an alphabet soup of regulators. Is the solution to our problem adding one more layer of calculation and regulation?

Having regulators compete with one another can be good on one level—it encourages each regime to do its best—but it can lead to regulatory capture, where the SEC lawyer is just punching his ticket before he moves on to become the compliance chief of a multi-billion dollar hedge fund. How quick might he be to shut down an offender?

Thoreau wrote, “Simplify, simplify. Our life is frittered away by detail.” A rational regulatory regime with clear simple rules—like a simple leverage ratio: assets over capital—might not be optimal, but it would be transparent. If the assets could be yours, they are yours, and count as leverage. A simple, uniform corporate tax rate brought in more revenue in Ireland per corporation than did a higher rate with more exemptions in Italy. That’s the power—and freedom—of simplicity.

In finance, there’s a lot of room to simplify. But it’s hard to get the balance right. As Einstein said, “Everything should be made as simple as possible, but no simpler.”

Douglas R. Tengdin, CFA
Chief Investment Officer
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