It’s time to spend a lot more money on far smarter financial regulation. My column for Financial News.
Nobody likes more regulators or more regulation. This antipathy towards watchdogs was neatly captured by Howard Davies, then chairman of the Financial Services Authority, when, shortly after the organisation’s formal launch in 2001, he wrote: “The celebrations in the City of London were muted. If there were parties, we were not invited.”
Yet one of the most durable consequences of the financial crisis is that the financial markets have had to get used to a lot more regulation and a lot more regulators, which between them add up to a lot more cost. The question is what do we mean by “more”, and to what extent does “more” mean better?
Perhaps, instead of piling more regulations on top of each other and throwing more regulators at the problem, we should be finding ways to improve the quality and sophistication of regulators, and with it the quality of regulation…
One thing is clear: over the past decade we have been doing regulation on the cheap. In fact, when you look at the cash cost of regulation, it is remarkable that regulators manage to get anything done at all. It looks like the industry has been “penny wise and pound foolish” in its approach to the cost of regulation, as James Angel, a professor at Georgetown University in the US, has argued.
In fiscal 2012, the FSA’s entire budget was just £470m, which is little more than a rounding error for the banks that it used to supervise (before being broken up into two separate regulators). To put this in perspective, the combined fines collected by the FSA from Barclays, RBS and UBS for Libor manipulation added up to £308m, enough to fund the FSA for nearly eight months.
If you add up the FSA’s budget over the past decade you get to £3.1bn, which is less than the £3.6bn in revenues earned by Goldman Sachs International, a decent proxy for the bank’s European business, last year alone.
This is not a uniquely UK-specific problem. In the US, regulators are struggling to get bigger budgets despite being beaten up by politicians for not having done their job properly in the first place, while simultaneously being asked to take on a lot more responsibility. The Commodity Futures Trading Commission, which oversees US derivatives markets, has asked for a budget of just $315m and says bluntly that it doesn’t have the resources to do the job the US government has asked it to do.
The Securities and Exchange Commission, which once complained that its budget is less than what the US military spends on marching bands each year, has asked for an increase in its budget of about a quarter to $1.67bn.
When you add up the cost of the CFTC, the SEC and the Office of the Comptroller of the Currency, you get to a combined budget of about $2.8bn. That’s less than half what JP Morgan lost on the London Whale trade last year. It would buy you about 100 Lloyd Blankfeins or keep Bank of America ticking over for a little more than two weeks.
Of course, these costs are a tiny proportion of the overall cost of regulation. In Europe in particular, there is a reserve army of civil servants and policymakers directly involved in financial regulation at national and international bodies. Far more significant than the cash cost of regulation, is the cost of implementation and ongoing compliance for those firms being regulated. And, on top of that, there are unintended opportunity costs of regulation such as its potential impact on economic growth or lost tax revenues.
So, you could argue that the headline penny-pinching is a false economy. The indirect (and far greater) costs of regulation would most probably fall if the industry were prepared to pay up for higher-quality regulators in the first place.
Over the past decade, the average pay per employee at the FSA has been a little more than £78,000. This is just one fifth of the average of £386,000 at Goldman Sachs International over the same period. Of course, the numbers at Goldman Sachs are skewed by the huge sums earned at the very top of the firm, but even if you assume that the top 10% of the staff take home half of the money, staff at Goldman Sachs still get paid roughly three times as much as the people that regulate them.
This pay differential inevitably has an impact on higher staff turnover (banks quickly hire the best people into their compliance and regulatory affairs teams) and lower levels of experience. And, without wanting to be mean to the hardworking and beaten up staff at the FSA and other regulators, who are no doubt motivated by other factors beyond monetary gain, it could mean that regulators fail to attract enough staff of the highest calibre. One banker uncharitably said that it was the people who don’t get jobs at credit rating agencies who end up working for regulators.
To address this, the funding for regulators needs to be significantly increased and the relationship between regulators and the firms they regulate needs to change.
Given the track record and reputation of regulators on both sides of the Atlantic, it is not just a question of throwing more money and more bodies at the problem (although it would be a good start).
More importantly, regulators need to be able to hire more and better people,who are not necessarily lawyers, who have a better understanding of markets and who are not treated like second-class citizens by those they regulate (we know that staff at JP Morgan yelled at staff from the SEC and called them morons over the London Whale incident).
For example, if the FSA were to have its headcount increased by 50% and paid its staff an average of 50% more, its successors (the Prudential Regulatory Authority and the Financial Conduct Authority) would have an extra 1,700 staff to play with and be able to pay them an average of closer to £137,000.
This would close the pay gap (and the cultural gap) with the industry, potentially attract higher-calibre candidates and the total bill would still only be a billion pounds a year.
There could be an opportunity for banks to put their promises of cultural change into practice, by offering staff to their regulators on secondment – particularly to help with policy formation – to start rebuilding trust and improve mutual understanding.
And right now there are thousands of people who used to work in the financial markets desperately looking for work that pays anything like what they used to earn. This could be the best opportunity in a generation for regulators to add people with deeper market knowledge and industry understanding to their ranks, and to begin the long process of changing the culture, quality and all-in cost of financial regulation.
–This article first appeared in the print edition of Financial News dated June 10, 2013