Comments on the current crisis – Regulation

So in the spirit of more regulation is good (the protest cry from the streets these days following Wall Street’s crisis), here are two ideas where we might be able to do more with less.

Federalize Insurance Regulation

Insurance regulation is a sad anachronism. Insurers are regulated at the state level, which means that the limited resources and limited talents available to the public sector are spread out across 52 organizations (Yes, Puerto Rico and Guam, along with all the rest of the 50 states have their own fully independent, fully staffed by your tax dollars, insurance departments each trying to regulate MetLife, Prudential, Aetna, CIGNA…)

Besides the financial analysts, policy reviewers and actuaries who are actually trying to do the work, each of those state departments has or uses the resources of an HR department, a legal department, a finance department, a publicity and lobbying department. And believe it or not a percentage of your car insurance premium goes to pay for the 52 state exams that every insurance company has to go through regularly, sometimes every year, each one equally superficial, each one equally repetitive, none really getting to substance.

Really, only New York’s and maybe California’s insurance departments have the talent and depth to understand what’s going on in an insurance company, and most small states follow their lead, but unless you want the next crisis to be the collapse of a big life insurer, let’s instead collapse all the anemic state departments into one federal insurance regulator. We’ll save a pile of money and increase the quality of oversight.

Adopt Principle Based Accounting – Dump SOX

After Enron collapsed our mis-regulatory response was a call for accountability in accounting. It manifested itself in a comprehensively crappy piece of legislation called Sarbanes-Oxley, known as SOX.

SOX is a vastly complicated and specifically detailed set of accounting rules. Very few people understand it in detail. Even the bill’s sponsors said they really didn’t understand all that the regulation entailed, yet hundreds of millions of dollars were and are spent because of it. It has been for accountants what Y2K was for IT consultants, a vast billing opportunity.

The most visible manifestation of SOX compliance is having hundreds of employees sign pieces of paper every quarter saying that they had done what they had done. Yep, I’m not kidding. I saw our SOX team running around every three months, across the globe, on a massive signature hunt, the results of which were reported at the board level to the polite disbelief of anyone with good business sense.

But we all did it because regulation said we had to and who cares what else didn’t get done. Satisfying the Reg 404 requirements (that’s the code section for SOX assessment of internal controls) trumped all other financial processes, because if you didn’t do it a guy with a badge and a gun would show up and you go off to jail. That was the intent of the regulations, find a way to arrest executives, as our auditor reminded us repeatedly and with somber seriousness.

Certainly SOX has done far more harm than good. Having watched our Finance department swell with hundreds of employees to satisfy the ridiculous need for meaningless documentation under SOX, I then listened to our SVP of Risk Management beg to be able to hire just her third employee. One could make a strong case that the resources that should have been manning the risk models on Wall Street were diverted to SOX silliness. It was interesting listening to her say that all the Wall Street Risk Management departments were being undercut by the need to hire finance talent for SOX. That was three years ago, in the seeds of our current crisis. So we missed that one by a mile.

The solution is to avoid specific regulatory requirements in regulation. It’s really not that hard. Principles Based Accounting would be the first place to start. Essentially what it says is you have to report based on a set of broad principles, not a set of rules, and each set of reports is judged based on its representation not on its compliance with a gotcha checklist. Moving to principles based accounting and repealing SOX would allow us to dump all the expensive SOX overhead and reallocate it to more critical functions, like perhaps, correctly modeling the complexities of derivatives.

So, as quaint as state regulation is, and as well intentioned as SOX was, its time for both to go. This is such a no brainer that it will never get done.

As I said with more and more of our citizens working outside the wealth creation part of the economy, essentially living off the surplus of a shrinking commercial class, it will be hard for us to resist the tools of institutional control prevalent in their world, and more regulation, probably more “do this, then this, then this” checklist regulation, will be a’comin.

I just hope we can use cooler heads and realize that for regulation to work it needs to be more comprehensive and less specific. Unfortunately I believe we will fail because that is exactly the opposite of how the non-commercial sector of our country thinks.


More from on the Financial Crisis

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Are Americans worthy of being saved?

Comments of the current crisis

Comments of the current crisis – Regulation

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