A Plea For Financial Calm

Eliot Spitzer is the former governor of New York.

The national ideological tilt has shifted fast, away from libertarianism and toward broad support for interventions like the new federal "pay czar," who will oversee banker compensation for bailout recipients. Such a sudden and dramatic reversal suggests that ideology has not been moored to steady principles. Instead, we have grasped too quickly at ephemeral data points and permitted our worldview to be shaped by panic. In this haze of hyperbole, we have an obligation to discern the more modulated truth. Indeed, if we now quickly move from lax regulatory enforcement to heavy-handed bureaucratization of our economy, we will be just as lost a decade from now as we are today.

To understand the shape of our response to the crisis, we must understand the crisis itself. We have experienced a failure of capitalism--not the failure of capitalism. We know markets are still the best way to allocate resources and to set prices and wages. But the first and essential corollary to any theory of markets should hold that they are fragile and must be protected. No matter how frequently large swaths of the world loudly shout, "We love the market!," virtually nobody does. In the absence of rigorous enforcement of rules, market players seek monopoly power and unfair advantages; they take risks at the undisclosed expense of others, or violate fiduciary duty. None of this means these actors are "evil" or "immoral." But their actions demonstrate that self-interest, unbridled by enforcement of rules, will destroy the very market so many people so ostentatiously claim to adore.

So, we can now dispose of that old canard that self-regulation preserves the integrity of markets. There is essentially no evidence that any self-regulatory entity--from the Securities Industry Association to the New York Stock Exchange--ever revealed or resolved a single structural flaw in the market place. Rather, they papered over and rationalized away all the bad behavior they witnessed.

But there was supposed to be another group designed and empowered to root out malfeasance and protect the commonweal: a large cadre of government regulators. There's a widespread assumption that these regulators were improperly armed to adequately protect the public, without sufficient statutory firepower or resources. That, of course, is supposedly being corrected in a wave of reform. Since the crisis broke, we have been treated to a vast array of proposals that remake government organization charts and create agencies with new names. This renovation, however, doesn't begin to solve our regulatory problems.

The truth is that multiple existing agencies already have, as part of their core responsibility and legal authority, the obligation to protect consumers and oversee financial markets. Take the Fed's failure in addressing the issue of excessive leverage, which posed a "systemic risk"; or the Securities and Exchange Commission's inaction while blatant abuses stared it in the face. The regulatory failures of the past decade were in large part failures of will and ideology, not power.

Our market has been--and will continue to be--undermined by regulators who are intellectually or ideologically unwilling to confront powerful market players. Too many of our regulators have been tarnished by the culture of Washington, where the constant movement between government and the private sector has created a fear of disrupting the status quo. It is an environment where stringent enforcement--the very type we needed--jeopardizes future confirmations, alienates potential clients, and engenders social ire. This cozy world isn't exactly corrupt. Rather, it perpetuates an insidious process of socializing the regulators and the regulated alike. Everyone emerges accepting a way of doing business that ultimately fails the public and the economy. Groupthink has prevailed, leading to an ideological conformity that forecloses challenges and alternative theories.

Effective regulation requires a more intellectually nimble regulator--a regulator that won't be duped by all the cosmetic changes offered by firms. After all, trading vehicles will be renamed, leveraged assets will look slightly different, but the underlying issues that jeopardize the economy will remain the same: excess debt, leverage, and lack of integrity.

The answer is only partly to place constraints on the ability of people to rotate back and forth between the public and private sectors--to jam up the "revolving door." The deeper answer requires asking the tough question of regulators: So what did you do about it? This is a question that must be asked by Congress. And there are similarly tough questions that must be asked of everyone hired at these agencies in the future--questions that help identify contrarians and independent minds. This is a metric that is tougher to measure than the quality of a law school attended or the rank one attained in a corporation, but it is vastly more important.

As we emerge from the crisis, there will be a temptation to over-learn lessons. The old system socialized risk and privatized gain. In our rush to reverse the damages wrought by this imbalance, there are many proposals (some of them already implemented) that bureaucratize decision-making and sharply limit private gain. There's the application of Sarbanes-Oxley to venture-capital firms, which has been neither effective nor useful, and has perhaps inhibited capital flows. And we have already added a federal "pay czar" to determine compensation for bailed-out bankers.

But, once again, we're missing the opportunity. Instead of adding bureaucracy, we should be using the government to help invigorate shareholders to police companies. They should be empowered to control executive compensation, eliminating all the conflicts that now encumber those decisions.

Shareholders, like all stakeholders, will make a better determination about the use of their capital than bureaucrats who don't ever suffer the downside of a bad investment. We need to facilitate opportunities for shareholders to actually participate in key decisions, and to deny those whose interests are not aligned from hijacking them. Strangely, we've heard a lot about executives and bureaucrats in this moment of reform. But shareholders, a force integral to the integrity and vitality of markets, have largely been left out of the discussion. We need them now more than ever.

By Eliot Spitzer:
Reprinted with permission from The New Republic.
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