Laws, Regulations, and Codes of Conduct in Society

Barry Ritholtz writes:

This will be a short but simple post, to clarify some fundamental misunderstandings about the purposes of laws, regulations, and codes of conduct in society.

Laws do not prevent crimes. We can legislate all the criminal laws we want, but there will still be bank robberies and drunk driving and murders. We pass laws not to prevent these acts from taking place, but rather, to make sure their is a very high cost to committing them.

In fact, we legislate criminal laws for three broad reasons:
1. Let people know exactly what is acceptable and unacceptable behavior.
2. Punish people who violate these norms.
3. Remove the dangerous people from society for the protection of everyone else.

We create corporate regulations in order to effect similar broad policy purposes:
1. Inform companies what is unacceptable economic behavior.
2. Punish corporate management who violate these norms.
3. Remove dangerous economic behaviors from society.

By economic behaviors, I refer to any impact a company has in the broader economy. This ranges from externalities such as pollution or financial risk to pushing the entire global economy to the abyss.

When it comes to laws, there is always a trade off: My freedom ends where your nose begins. Anything I do that threatens your health, safety or general well being is fair game for criminal laws; Anything a corporation does that threatens these same things is fair game for regulation.

There is a nefarious group of corporate cronies who abuse the word “Freedom.” They employ the word to mean curtailing everyone else’s freedom. They seem to believe Freedom is a license to behave recklessly, to endanger third parties, to risk the economy.

It is not.

The sooner we recognize these simple truths, the faster this society will be heading in the right direction. I suspect that the longer we delay recognizing these truths, the slower our economic recovery will be.

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Ben Bernanke's Speech

“When historical relationships are taken into account, it is difficult to ascribe the house price bubble either to monetary policy or to the broader macroeconomic environment.”
-Chairman Ben S. Bernanke, Federal Reserve

read the entire speech

Barry Ritholtz responds:

An honest assessment of the crisis’ causation (and timeline) would look something like the following:

1. Ultra low interest rates led to a scramble for yield by fund managers;

2. Not coincidentally, there was a massive push into subprime lending by unregulated NONBANKS who existed solely to sell these mortgages to securitizers;

3. Since they were writing mortgages for resale (and held them only briefly) these non-bank lenders collapsed their lending standards; this allowed them to write many more mortgages;

4. These poorly underwritten loans — essentially junk paper — was sold to Wall Street for securitization in huge numbers.

5. Massive ratings fraud of these securities by Fitch, Moody’s and S&P led to a rating of this junk as TripleAAA.

6. That investment grade rating of junk paper allowed those scrambling bond managers (see #1) to purchase higher yield paper that they would not otherwise have been able to.

7. Increased leverage of investment houses allowed a huge securitization manufacturing process; Some iBanks also purchased this paper in enormous numbers;

8. More leverage took place in the shadow derivatives market. That allowed firms like AIG to write $3 trillion in derivative exposure, much of it in mortgage and credit related areas.

9. Compensation packages in the financial sector were asymmetrical, where employees had huge upside but shareholders (and eventually taxpayers) had huge downside. This (logically) led to increasingly aggressive and risky activity.

10. Once home prices began to fall, all of the above fell apart.

It became readily clear to me once I dug into the data, legislative history, market activities, etc, that there was no one single factor that caused the collapse. Rather, an honest reading of events was that there were many, many failures occurring in a very specific order that contributed to what occurred.

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