Andrew Hofer offers a persuasive argument that less, not more, regulation would be a better solution to prevent future debacles like that of Enron.
Politicians tend to think that regulations fix problems, but as Hofer argues, the reality is that proscriptive regulations tend to create a market for even more complex derivatives (which can become a cycle, as we see in the tax code, with complex rules leading to complex tax shelters, leading to ever more complex tax rules and even more complex tax shelters). Hofer writes,
If you haven’t figured it out yet, regulation is often the derivative salesman’s best friend. Complicated rules encourage complex transactions that seek to conceal their true nature. Regulatory rules on investment quality have always had this perversely symbiotic relationship with Wall Street. And the same can be said for the ridiculously complicated federal taxation rules and increasingly byzantine Financial Accounting Standards, both of which have inspired massive derivative activity as the engineers find their way around the code maze.
The solution, though, is relatively straightforward — replace regulation designed to dictate a firm’s behavior with regulation designed to force firms to disclose, disclose, and disclose some more. “If Enron had to disclose the books of its many affiliates,” Hofer writes, “they never would have entered into all of these accounting-driven transactions.”
Hofer’s article goes into a lot more detail, especially about some of the shenanigans in the insurance industry caused by excessive regulation.
Source:
Derivatives and Regulation. Andrew Hofer, January 22, 2002, MoreThanZeroSum.Com.