Friday, August 31, 2007

And another thing...

I want to continue my rant on the New York Times' recent article about how the subprime mess has led some in the "international community" to call for more input into US financial regulation. (See my screed here and the NYT article here.)

Clearly, greater international regulatory cooperation can be a great boon. However, the arguments posited by Peter Bofinger and Professor Dick Bryan in Heather Timmons' and Katrin Bennhold's article are not among the reasons we need this cooperation. International regulatory cooperation exists for two purposes -- so bad guys can't use the international system to undermine national sovereignty (quite the opposite of what Bofinger is suggesting) by permitting regulatory arbitrage; and, second, so the world's regulators don't step on each others' feet so much, to the detriment of global markets.

I'm harping on this point because these academicians really should know better. For example, the article notes:

Their argument is simple: The United States is exporting financial products, but
losses to investors in other countries suggest that American regulators are not properly monitoring the products or alerting investors to the risks. “We need an international approach, and the United States needs to be part of it,” said
Peter Bofinger, a member of the German government’s economics advisory board and a professor at the University of W├╝rzburg.

While regulators in the United States have not been receptive to the idea in the past, analysts said that Europe and Asia had more leverage now. Washington might have to yield if it wants to succeed in imposing bilateral regulations on government-owned investment funds from emerging economies.

“America depends on the rest of the world to finance its debt,” Mr. Bofinger said. “If our institutions stopped buying their financial products, it would hurt.”

Rather than an argument that the US regulators are asleep on the job, isn't this an argument that the European regulators aren't monitoring the risk management practices of their own firms? Were these firms really snookered into believing that the subprime mortgage securities were safer than they are -- particularly when anyone with half a bucket of sense could tell you otherwise?

Likewise, it is certainly true that US regulators have not been keen on engaging foreign governments in determining what US financial regulations should be. Indeed, I suspect that if the US public knew anyone in the United States was even considering it, they would be hanged from the nearest lamp post (which may explain why Basel II is as complicated as it is -- US banking regulators, after all, have such skinny necks). All of that said, I fail to see why US financial regulators would particularly care if foreign investors, in particular, stopped investing in any specific US security. Regulators might care if investors, writ large, started having a problem, but there is nothing magical about foreign investors.

And this, fundamentally, is why these academics' arguments fail. The Fed, the SEC and most other US financial regulators draw no distinctions between US and foreign investors. This is the strength of the US system and why the United States is able to import capital so cheaply, regardless of how many boneheaded statements Congressional leaders might make about foreign capital. What's good for foreign investors is good for American investors, and vice versa. US regulators are unlikely to take advice from foreign regulators who historically have a problem with attracting even domestic investors to their own market.


Ryan said...

I thought the reason why international regulatory cooperation can be good is because it might avoid a regulatory race-to-the-bottom or race-to-the-top (this is, if anything, the opposite of maintaining national sovereignty).

M.D. Fatwa said...

That depends on why you wish to avoid a race-to-the-bottom or top. It could be a way of maintaining your own sovereignty, if the "race" is going in the opposite way you want it to.

Ryan said...

If there's a race to the bottom/top, there is by definition an interjurisdictional externality -- it's a prisoner's dilemma. But if it's not a prisoner's dilemma, but simply a case of one side wants one thing and one wants another, why does anyone agree to something that doesn't help them? Surely you're not saying that regulators do things that aren't in their jurisdictions' interests?