As it was on the last page of the paper, the WSJ’s coverageof the annual gathering of economic Nobel laureates was easy to miss. There were the usual and predictable debates between proponents of increased regulation of financial markets and those who have only disdain for such tinkering. But there seemed to be a thread of agreement which should not be lost: that reactive regulatory moves (of which Sarbanes Oxley is the poster child) almost never work. In contrast, I was intrigued by an idea introduced by 2000 laureate Daniel McFadden:
a commission that would vet financial products beforetheir release, akin to the U.S. Food and Drug Administration’s evaluation of drugs before they are released to the market. Mr McFadden said, “we may need a financial-instrument administration that tests the robustness of financial instruments and approves only the uses where they can do no harm.”
Of course, one must immediately question the practicality of such an agency. First, in financial markets, “harm” is usually in the eye of the guy who was on the wrong side of the trade. Second, analogizing anything to the notoriously sclerotic FDA highlights at least one difference between economists and marketeers. And more substantively, financial instruments are introduced continuously to exploit perceived market discontinuities that may be very short lived. Much of this constitutes legitimate financial innovation which a Wall Street version of the FDA would have a difficult time allowing to flourish. But there’s a germ of an idea in there somewhere.
In any case, one of the first priorities of the new Treasury Secretary should be to appoint a serious commission to re evaluate and recommend changes to the system of American financial regulations which has grown so unwieldy and ineffective.