Wednesday, September 24, 2008

For a Taste of Governmental Regulation, Consider the IRS

I wrote about the distortive effect of government regulation of business, below. I'd like to stress that I'm by no means a rabid fan of unmitigated raw capitalism. Milton Friedman and Ayn Rand make me downright queasy. But while I recognize the absolute necessity of financial regulation, I'm also aware that it's always a compromise with the devil - the devil being Kali, the Hindu Goddess of Violent Tumultuous Change. 

Regulation creates unintended consequences, because regulators can never anticipate how business will scramble to heed (i.e. work around) a regulation. Worse ills than ever can arise as a result of a given application of medicine. And at times of crisis, when the economy's struggling to find a foothold, aggravating the situation with lots more regulation/distortion is rarely a good idea.

I just read an interesting explanation of how regulation can feel from the business point of view (I especially liked the IRS analogy). The following was posted anonymously to an Internet message board from a top manager at Apple during the SEC investigation of their options backdating issue last year (I've edited for grammar and clarity):

Anyone who has dealt with Government regulation will tell you it's very vague and misleading at times. If you ask the government to tell you what they mean, they will tell you that they can't tell you. You simply must develop policy to address the law or regulation, and if at some time in the future the government thinks you were wrong, they will come after you. They never tell you whether you got it "right", but they will come after you real fast if you got it "wrong"!

This is what happened with the whole stock option thing. They had rules that were not clear, and companies and individuals interpreted them in their favor and now the SEC has said "you're all wrong and will pay."

No different in doing your taxes. Call the IRS up and ask them if you can write something off on your taxes; you'll get ten different answers, and, if you get audited, it does not mater what they said before, the auditor has the final say.
Update: regarding this current bailout situation, while hasty regulation would be a poor idea, the money should definitely come with strings attached (i.e. give taxpayers a piece of any upside for their investment). Bill Clinton was dead right about this in his Daily Show appearance last night.


Big Fella said...

As a long time member of middle management of a corporation subject to heavy federal regulation, hence, strong internal risk management policies, you get the feeling that the auditors and the regulators can be very vague in counseling you to adhere to any specific operating practice, and yes that may make it difficult to assure yourself that you will ultimately be in compliance. However, common sense, honest and ethical business practices, recognition of fiduciary responsibility and lack of greed, go a very long way towards staying out of trouble, either with regulators, or actual financial risk.

It's small minded greed and lack of responsibility that gets so many people in to trouble.

Jim Leff said...

Oh, for sure.

But we live in a system where greed is not only not a deadly sin, but is the very grease that makes the whatever cogs do. I don't happen to be greedy myself, but that's why I've never really cogged.

As for "responsibility", the responsibility of corporations is to maximize value for their stockholders. Period. It's not just their preference, but their imperative to work right to the bone of regulation - same as when it comes to minimizing more tangible costs. A corporate executive who chooses to be a mensch and leaves headroom rather than gobble every last buck with furious abandon is, under our system, failing to do his/her job.

Responsibility is only taken insofar as it involves playing diligently between clearly established lines (i.e. clear regulation). But the lines are never clear. Much like Greenspan's reluctance to EVER state anything clearly and directly (for fear of being penned in), regulators actually avoid clarity. So the problem is that aggressive (yes, greedy) business work (inevitably) close to an (inevitably) fuzzy bone.

It's just one of the many aspects in which regulation, necessary though it is, introduces distortion, inefficiency, and unintended consequences.

Big Fella said...

Agree that there is a responsibility of a corporate functionary to return value to the shareholders. But I think catering to overreaching greed, at potentially greater risk (on various fronts), rather than aiming for reasonable return on investment, can be ultimately fatal to the shareholders. Part of corporate responsibility is to avoid adverse risk.

What I think many fail to understand is that the pursuit of greater and greater profits, one can only stuff so much money in to one's pocket before a seam will split open.

People seem to lose perspective in pursuit of short term financial gain without regard to long term consequences, or in my opinion, without ethical qualms about potential consequences to themselves or others. The bankers and fund managers that granted and packaged the bad loans, who were smart enough to conceive of these investment schemes were smart enough to understand how they violated financial common sense, in terms of the quality of the loans, and were thus, in my mind criminally negligent due to their overreaching greed.

I believe that regulation can create an environment where every effort would be made to thwart it by those being regulated, so effective regulation requires an ethical commitment on the part of the regulated, but also diligence and intelligence by the regulators, without being diluted by the executive branch of government through their policies and personnel appointments, and without, somehow, a Congress that seems to be so heavily influenced by political ideology and the lobbying establishment.

Dunno if I am making a lot of sense here, bottom line, everyone's actions in all of this need to be balanced.

Jim Leff said...

We can't expect (much less count on) players to act in a balanced way. So we count on market forces to balance it all out, via its endless cycle of boom/bust/boom/bust.

Welcome to bust.

Big Fella said...

Yeah, I keep coming back in my mind to that old phrase "the market will self correct", and in my mind if self correction means that some of the big players will lose their shirts, so be it. But it sure does not make me, as a taxpayer, happy to be holding the bag for someone else's poor decisions and greed, as Bush, Bernanke and Paulson want us to do.

The last 8 years have been bizzare.

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