Monthly Archives: May 2017

Perhaps we need peer regulation in finance

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Guy Rolnik writes,

After acknowledging that the OCC knew of the issues within Wells Fargo as far back as 2010, it stated that “The OCC did not take timely and effective supervisory actions after the bank and the OCC identified significant issues with complaint management and sales practices.” The report also said that the team in charge of Wells Fargo “focused too heavily on bank processes versus what those processes were actually reporting” and “reached conclusions without testing or determining the root causes of complaints despite the existence of red flags.”

Pointer from Mark Thoma. Read the whole essay, which concludes,

Executives knew, board members knew (or should have known), and regulators knew almost all along, yet failed to do anything about it.

To me, this hints at the problems with the way that we currently try to deal with misbehavior on the part of financial firms. Top executives can be unreliable. Boards of directors are often unwilling or unable to delve deeply into operational issues. Regulators are just going through the motions.

There is one constituency that often really cares about financial firms that misbehave: their peers. When you lose customers to a firm that is using shady products and sales practices, you get angry. Unfortunately, the most profitable response is often to copy what the bad guys are doing.

I suggest creating a Financial Ethical Standards Board (FESB), which is analogous to FASB. FESB would provide a forum for discussing and offering guidance on ethics in the financial industry. If you see a competitor doing something unethical, you can take your complaint to FESB. FESB would have the ability to name and shame the wrongdoers, and it would have the ability to focus the attention of regulators.

I believe that a down side of FESB, or peer regulation in general, is that firms would try to use it to resist innovation that they find threatening but which in fact is not unethical. But I think that we can live with this potential down side in exchange for better regulation of the financial industry.

The way I see it, ordinary regulation simply gives clarity to banks about what they can get away with. As the banks adapt, ordinary regulation becomes ineffective, or even counterproductive. Peer regulation would be more adaptive. I believe it would be better, although nothing is perfect.

Affordable Housing is a Supply Problem

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Ed Glaeser writes,

If demand alone drove prices, then we should expect to see places that have high costs also have high levels of construction.

The reverse is true. Places that are expensive don’t build a lot and places that build a lot aren’t expensive. San Francisco and urban Honolulu have the highest ratios of prices to construction costs in our data, and these areas permitted little housing between 2000 and 2013. In our sample, Las Vegas was the biggest builder and it emerged from the crisis with home values far below construction costs.

Pointer from Tyler Cowen.

Glaeser also writes,

No locality considers the impact that their local rules may induce more building elsewhere.

This suggests a new maxim: Environmentalists impose negative externalities. If construction harms the environment, then diverting construction elsewhere harms someone else’s environment. Along the same lines, when we regulate fossil fuels in the U.S., we probably shift production to other countries which have a higher intensity of fossil fuel use than we do.