The Over-Codification of Financial Regulation

Thomas M. Hoenig, vice chairman of the Federal Deposit Insurance Corporation from November 30, 2012 to April 30, 2018, recently participated in an interesting discussion at Metropolitan State University–Denver.

I was pleasantly surprised to hear Hoenig’s concerns about one way to approach financial regulation. Financial regulation is approached as a very long and detailed list of “if … then …” propositions. These propositions are intended to cover all potential scenarios and contingencies. 

This centralized and technocratic point of view clashes with a basic principle of the rule of law. Regulations should be short, clear, and enforceable. This means the regulatory authority (whose existence I’m not questioning in this post) has to have discretionary judgement. There are two reasons to take this approach (not discussed in Hoenig’s presentation). One is that since regulation cannot be complete, there will always be some discretionary judgement. The other one is that the discretionary room given by simple and clear laws is less costly than endless, complicated, and unclear regulation.

Besides this trade-off on how to approach regulation, Hoenig expressed concern that what regulation is actually trying to do is run the regulated business rather than police it. A traffic patrol checks whether drivers are not exceeding the speed limit; it does not drive the car for them. Similarly, regulation should police economic agents and make sure they abide by the law, not indirectly run the business through excessively codified regulation.

Hoeing also made other comments consistent with his take on financial regulation. The first one was the misapplication of formal (meaning mathematical) methods in economics. This is the technocratic road to focus on a tree and miss the forest. It’s no surprise that economic policy can be mathematically consistent but economically inconsistent. The second was advice to students planning to be future economists. I’m very sympathetic to his advice, which consists in studying broadly (history, philosophy, psychology, etc.) rather than become technocrats whose training has narrow application.

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Nicolás Cachanosky

Nicolás Cachanosky is an Assistant Professor of Economics at Metropolitan State University of Denver. With research interests in monetary economics and macroeconomics, much of his recent work has focused on incorporating aspects of financial duration into traditional business cycle models. He has published articles in scholarly journals, including the Quarterly Review of Economics and Finance, Review of Financial Economics, and Journal of Institutional Economics. He is co-editor of the journal Libertas: Segunda Época. His popular works have appeared in La Nación (Argentina), Infobae (Argentina), and Altavoz (Peru).

Cachanosky earned his M.S. and Ph.D. in Economics at Suffolk University, his M.A. in Economics and Political Sciences at Escuela Superior de Economía y Administración de Empresas, and his Licentiate in Economics at Pontificia Universidad Católica Argentina.