[author: Rick Jones]
Last year, I wrote a commentary entitled Contagion. That commentary was inspired by the early days of the meltdown of the crypto currency market (long before SBF made the whole space way more notorious with a whiff of polymorphous titillation and the reveal of sad politicians now bereft of a future income stream). The crypto mess reminded me of the subprime crisis that enveloped our market a decade and a half ago and triggered the conflagration of cascading losses across virtually all financial assets and products. (It can happen again…probably; no, strike that, certainly will at some point happen again).
But today I want to talk about regulatory contagion. Contagion: A communication of a disease from body to body by direct or indirect contact. The elements of contagion are (1) transmission and (2) a bad outcome. Think the Black Plague or Covid (or worse Covid).
Our regulatory enterprise (if one can call the beavering of our apparatchiki an enterprise) tends toward contagion as regulation begets regulation and the notion that no problem, concern, distress, inequity or even discomfiture does not deserve a regulatory fix. Birds gotta fly and regulators gotta regulate.
A considerable bulk of regulatory extrusions into the banking and capital markets space over the past decade has been ineffective and has been burdened with material negative externalities not perceived, or at least not appreciated by the regulators (even when we told them so…perhaps most adamantly ignored when we told them so). Regulatory action often seems like vanity projects for those who devotedly believe in the efficacy of government action and have the sort of ideological clarity that is a bulwark against awareness of troublesome facts. They often appear to be imbued with a certain sense of omniscience, a sense of certainty, insensitive to both the negative externalities of regulatory initiatives and the possibility of unintended consequences.
Is it that the regulatory apparatchiki doesn’t particularly like our industry? Is it that they are deeply suspicious of banking? Of lending writ large? Of Wall Street? Are we, for them, bureaucratic catnip?
Perhaps it is unnecessary to make the case but there are obviously many recent examples of regulatory overreach by those imbued with the love the prescriptive power of government action.
Does anyone really think the risk retention rules have achieved their purported goal of making sponsors construct safer pools for investors (why, by the way, do we need the government to encumber our business with prescriptive rules to protect sophisticated institutional investors who make their money by understanding complex, illiquid investments…just saying).
How about the proposed Basel Endgame Rules? Perhaps this is cheating because the rule hasn’t been approved and there’s considerable talk that it might be materially revised. Nonetheless, it reflects the view of the regulators. (It’s gone away for the moment, but next year, might be a different story.) Securitization is being treated much worse than any other form of capital formation. Why? Well, perhaps because the Europeans, who largely authored the Basel Rules have never liked securitization and seem to view it some sort of an Anglo-Saxon trick. Perhaps it reminds the French of Agincourt. It’s feel-good-bad news policy. Facially, and in the imagining of the economically illiterate and those amongst our politicians who are happy to give fright to the folks for political gain, more capital intermediating risk is always an unalloyed good, right? (Spoiler alert: It’s not.). Who could ever object to requiring banks to be better capitalized?
Okay, if we made the obvious case that regulatory action is not always brilliant, but is contagion a real thing; something we need to worry about? Is regulation in one sphere, in one industry, that is designed to impact one behavior, likely to metastasize into other spheres, other industries and impact others’ behaviors? I think it is.
There’s plenty of examples of narrow casted and perhaps fundamentally rational regulation metastasizing. Remember, the Home Mortgage Disclosure Act, commonly known as HMDA. The original act was passed in 1975 and was focused on potential discrimination in home mortgage lending.
Now, as HMDA is being administered by the CFPB, the regulators have concluded that it should be expanded to multi-family lending and require disclosure by bank and non-bank lenders of the potential discrimination in how these business-to-business loans are made. Is there any real support for this in the legislation? Silly question; of course, there’s not, but it seems like the right thing to do from the perspective of the CFPB and until someone stops them, they will do it.
And then there’s the recent effort by the SEC to extend the penny stock rules into the asset-back world. This literally makes no sense whatsoever and was entirely unworkable from the get-go. But you can see the surficial appeal to a progressive-minded regulator. It didn’t happen, but the effort was made. How about the efforts by the SEC to become an enforcement agency with respect to environmental risk and other social issues? How about the SEC’s efforts to include disclosure about ESG and other non-financial metrics in its proposed Pay for Performance Rule? There’s the SEC’s Conflict of Interest Rule. Only a bit of Dodd-Frank DNA here and that was used as an excuse for a rule widely wider than any evidence of malfeasance. How about the SEC’s proposed Rule 15c2-11 requiring the distribution of public information to investors in the 144A market protecting investors who can’t invest in 144A products? How about the new preferential investor treatment rules with respect to funds? Enormous departure from SEC decades-long policy. Who’s that protecting? Can you find much support for it in the statute? Not to be left out, the banking regulators also want in on ESG and other social issues and threaten to propose a number of rules, endeavoring to define all this into its regulatory remit with respect to safety and soundness. Finally, there are dozens, if not hundreds, of executive orders issued by the White House during each of the past two administrations, the very essence of rules uncoupled from statutory authority. In a shining moment of sanity, some of this has gone away for the moment, but let’s focus on the word “moment” in that sentence. Use your imagination here about where it might go from here (regardless of who takes the White House, with both parties evidencing a serious populist bent).
We need to address this. We need a broken windows approach to regulatory change. The original broken windows policy was championed by Commissioner William Bratton of the New York City Police Department years ago. He observed, rightly, that small crimes, urban disorder and antisocial behavior beget more crimes, and more serious crimes. As a metaphor for us, it seems to me that regulatory creep begets more regulatory creep. The tide comes in further and further each year. Regulation, almost always deemed successful by the regulators, encourages a mindset that more and more ought to be controlled, regulated and intermediated by the government.
What might we see over the next several years? We might see the Basel III Endgame Rules in their current form championed by a new administration. We might see a significant effort to extend the existing regulated lending environment to the non-bank space. We might see the SEC get into the ESG and other social engineering businesses in a big way. We might see the banking regulators doing the same. We’ll continue to see more pressure to reconcile public and private disclosure in the securities arena. Remember Reg AB which continues to suggest the disclosure regime should be extended to the 144A. market. Might 15c2-11 rear its ugly head once again?
Our self-perpetuating regulatory cohorts will continue to hoover up ambiguity, uncertainty and fuzziness in statutory language, mix in a bit of the Chevron Doctrine (you don’t really believe that just because the Supreme Court has overturned the Chevron Doctrine, the instincts and the behavior behind it are going away, do you?), to intrude with new rules and regulations into almost every corner of our business. They seem willing to conclude that they can do just about anything that the denizens of the heights think would be consistent with God’s will. Each regulatory agency succumbs to rulemaking envy; if everyone else is exceeding their historical remit, why not us? If the SEC can regulate moustaches, we can too! As this pattern continues, it becomes more routinized, it becomes more customary; it might become acceptable. Who cares if my statutory remit is workplace safety, I think I should get in the securities regulation game! Why not? No one objects and the regulatory high water mark is ever higher.
We need to at least impede these tendencies. We need to force the government to make its case. We need, where appropriate, to resist regulatory intrusion. The hard part is that those of us in the CRE space need to do this even when the newest regulatory bad idea does not directly impact our business. Regulatory creep is always dangerous. Hey, no worries! It’s not us in the crosshairs this time. It’s the hedge fund industry, or it’s ABS or it’s residential securitization. Worry, please. If it happens there, it will happen here. We need a cross-industry, connect-the-dots broad based broken window’s approach to regulatory change.
We’re surely not going to convince the regulatory estate to change their spots, but it’s our job to at least make them work for it. It’s time to once again recommit to support of our trade organizations GR functions. It’s a time to support our PAC and lobbyists; it’s time to be actually involved, to spend our personal time and energy providing the sort of information and support that our trade organizations need to be effective advocates for our cause.
I know that there’s certain tragedy of the commons here. Can’t I just stick to making money and let somebody else do the conference calls, review the comments, attend DC fly-ins to talk to our gloriously elected leaders? Sure, it’s alluring, but ultimately, we all starve.
They are, with absolute certainty, coming for you.
