The limits of financial regulation

Running on New York-area news radio stations these days is a commercial for a municipal bond offering by a special-purpose New York City taxing authority.
The radio spot explains the need to rebuild the city’s infrastructure and states that the bonds being issued are free of federal, state and municipal income taxes.
After the pitch comes the gobbledygook: A boilerplate disclaimer proclaims something like, “This shall not be construed as an offer to sell, which can only be made through an offering statement,” completely contradicting the entire commercial. Didn’t listeners just hear a pitch to buy tax-free city bonds? What’s the point of a radio commercial if not to get listeners to buy something?
The puzzling nature of the radio commercial is just one sign of the loony state of financial regulation. Every financial product or service comes with reams of disclosures and disclaimers intended to protect investors, yet little of the information is comprehensible or even read by investors.
Those of you who provide financial advice labor under schizoid regulation, too. Brokers — who usually are called financial advisers — come under the umbrella of the Financial Industry Regulatory Authority Inc. of Washington and New York and must adhere to a suitability standard.
Registered investment advisers — who also usually are called financial advisers — come under the umbrella of the Securities and Exchange Commission and must adhere to a fiduciary standard.
Most investors don’t know what either of those standards mean, haven’t a clue about the differences between standards and don’t give a darn either way. They just want to know that the person handling their money knows what he or she is doing. Yet neither standard really assures that.
Since the existing cornucopia of financial regulation didn’t prevent the current mess in which we find ourselves, the mood of the public and its representatives is to increase and improve regulation. That might make sense if everyone could take a dispassionate look at the current problem and discern at which points rules were missing.
One core cause of the credit crisis was the issuance of mortgages to people whose income and wealth traditionally would have been too low to qualify for a mortgage. The old rule of thumb — 20% down and a mortgage payment that was between 25% and 30% of monthly income — was never a law, just a commonsense way of doing business that evolved over time and worked.
Of course, once mortgages were securitized and concerns about repayment were atomized among tens of thousands of bondholders, the old common sense approach vanished. Should there have been a law that said you can’t securitize mortgages? Should there be a law requiring 20% down?
My personal belief is that enacting a law or rule for every possible contingency is moronic. We have to rely on common sense and people’s natural desire not to lose their shirts — backed up by rules that have muscle and really protect the public.
The best analogy I can think of is that of building codes requiring sprinklers in office buildings. Obviously, it is in the interest of a landlord to protect his building, and that should make him or her willing to bear the cost of installing a firefighting system. But just in case the landlord wants to cut corners and save a few bucks, there must be laws that protect the public by requiring sprinklers.
When our newly elected officials start working on new securities laws, let’s try to get them to think about requiring sprinklers and not banning office buildings.

Evan Cooper is deputy editor of InvestmentNews.

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