Modest Proposal For Bank Regulation: Give Them a Small Bank

Modest Proposal For Bank Regulation: Give Them a Small Bank by David Merkel, CFA of Aleph Blog

It takes a thief to catch a thief.  Thus I have a modest proposal for bank regulation.  This could be applied more broadly to other forms of financial regulation also.

Why not require that all regulators spend time managing banks before they are appointed to be regulators?  I think this would be very instructive to those who would become regulators, because they would see how issues at banks appear from the other side.

I am not suggesting that potential regulators “go native” and become sympathetic to banks.  Working inside a financial institution can do the very opposite, and inform a regulator on what to be careful about.  I want regulators to have the smarts that an insider perspective gives.

Think of me for a moment.  I am not a fan of the insurance industry; I also don’t hate it, but I know it well.  I know where the warts are.  If I were a regulator, I would be feared by the industry, because there is almost nothing that I don’t know about insurance in broad.  (I.e., I am not trying to brag, but I think that I am competent in analyzing insurers.)

Modest Proposal For Bank Regulation: Give Them a Small Bank

My point is that we want intelligent regulators that cannot be bamboozled.  That only comes with significant industry experience.

But industry experience isn’t enough.  You want people who are intelligent critics, who can look at the industry and say that certain practices are wrong from a solvency or market conduct standpoint.

And thus I say, “Give them a small bank.”  Let the Federal Government set up a bunch of small banks for prospective regulators to help manage for a few years.  Being part of a senior management team would cue them into a wide number of problems as they try to make money in a competitive market.  Let them interact with their regulators as well.

I write this because when I read what most broad bank regulators at the highest levels say, I think, “All you can do is suggest things should be tighter, but you have no good reasoning for what or why.  Would that you understood the industry you are regulating.”

In general, it is a bad idea to have academic economists in regulatory positions, because they do not understand what they are doing, but merely follow their ideology.  Far better to have practitioners that are skeptics be regulators, because they really know what is going on, and will not spare the industry over abuses.

As a dear friend of mine once said, “To truly loathe the public schools, you have to be one of the teachers.”  In the same way, I say make the regulators work for the banks before they regulate them, so that they can properly loathe them.



About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.