Comment Rescue: KenB on Regulations

Over at Koz’s guest post, there was an exchange regarding people who poll businessmen and the questions they ask. Tom quoted a Washington Examiner piece:

Because “President Obama’s Executive Branch and regulatory policies have hurt American small businesses and manufacturers,” according to 69 percent of the business owners surveyed.

To which my response was:

I wonder if anyone ever polls businesspersons for specific regulations they want to overturn, instead of the regulation boogeyman.
Because I’ve talked to enough businesspeople to know that at least some industries are unnecessarily regulated, but quite often the problem with undoing that is knowing which part to tug on first.

And KenB returned with:

This is what I used to think about objections to regulation as well, but my experience working closely with CMS and health plans over the last decade has taught me that there is such a thing as “too much regulation” full stop. It can get to a point where it’s practically (or sometimes genuinely) impossible to stay compliant with all of the different rules. Every individual regulation can be perfectly sensible, but in the aggregate they can be unmanageable.

Ideally the lawmakers/bureaucrats would have some concept of a “budget” for regulations in a given area — acknowledge that they each have a cost and that there’s a cost ceiling, and then work to identify the best/most important set that will fit in the budget.

Bold emphasis mine.

Now we can unpack that a bit.

I happen to agree with KenB, regarding the contention that the rules can be literally self-defeating in some industries.  Generally.  But there are two issues with regulation and regulatory burdens.

Issue One: Audit is Waste

Bruce Schneier is fond of saying “Security is a tax on the honest”.  This is generally true.  Basic security is going to give you benefits beyond just protecting yourself from misbehavior; well-engineered security systems are hard to build, and taking a strong engineering approach to anything is going to make it less brittle.  So in addition to protecting yourself from nefarious agents, you’re also going to be building in prevention and response systems that will likely help you against things like natural disasters.  Audit, on the other hand, is worse.  If everybody is honest, having basic security principles will still probably provide me with some benefit against unforeseen events… but if everybody is honest, we’re also following all our documented practices, which means that attempting to verify that we’re following our documented practices is pouring money into a pile and setting it on fire.

In the real world, of course, everybody fudges on some of their documented processes.  To some extent this is actually a good thing; it’s better to adjust the rule to the reality than the other way around.  Audit does keep you honest, though – a proper audit will tell you which of your rules you’re violating, so that you can either change how you do business to match the rule, or you can change the documented process to match the way you do business.  So in the real world, audit has a purpose that is largely under-recognized.

But the larger point stands: in most industries, across most actors, most people are reasonably honest.  They might steal a paper clip here or there, but if they fudge a rule it’s usually to get a job done, not to decrease someone’s safety or embezzle money.  And throwing more rules in their way for the sake of a small number of bad actors is taking the systemic approach of decreasing everybody’s productivity for the sake of making it more difficult for bad actors to get away with stuff.

This is ass-backwards.

Issue Two: Nobody Wants To Go To Jail

The second issue with regulatory re-alignment is that the regulators are always trying to tackle the previous problem, and they’re always tackling it along these lines: “The last guys committed what anybody with half a brain would consider fraud, but we didn’t have explicit rules saying that what they were doing was fraud, so they’ll probably get away with it, because they have lots of money and an army of lawyers.  So let’s make what they did last time explicitly illegal”.  There are two immediate problems with this approach.

The first problem is that you’re playing whack-a-mole, obviously.  You’re not going to prevent any new crime using a new loophole that is discovered by those pernicious actors who look for the next way to get around the system.  You may even create the new loophole with the new rules you put in place.

The second is that you’re probably not even going to prevent the debatable-crime that you just caught people doing, because people aren’t going to go back to doing the same thing they just did.  You blow up AIG, you can pretend (once) that you didn’t know that you were playing a shell game.  You work at Moody’s and you grant A-paper status to securitized mortgages you can stand there dumbfounded and say, “Hey, we didn’t know this was actually risky!”  You do it again, it’s pretty hard to say, “We didn’t know that would happen again!”  Corporate malfeasance has a pattern, and (outside of actual, non-debatable crime) repeating what you did last time is actually pretty uncommon.  So you just created more difficult-to-follow rules to prevent something that wasn’t likely going to happen again anyway.

Everybody’s worried about mortgage companies issuing risky loans again.  “They’re just going to go back to the same thing that got us into this mess!”  Mortgage companies are fighting right now to avoid buying back their broken loans.  They’re gun-shy about foreclosures and they’re gun-shy about new loans.  Right now, the internal process requirements for most loan companies are more ridiculous than their actual legal requirements, because nobody wants to get fired.

SOX was a response to Enron, WorldCom, etc., and it attempted to solve the problem of companies behaving badly by making it harder for companies to behave badly.  This unfortunately had the side effect of also making it more difficult for companies to behave in any way at all.  The home loan environment is vastly more complicated right now than it was in 2006, but the amount of paperwork addresses one of the eleventeen problems with the housing crash, and it does it in the least efficient way possible, and right at the time when we want mortgage companies to have streamlined operations instead of extremely klunky ones.  My brother just went to refi, and his paperwork was delayed a day because he didn’t include a piece of documentation.  The missing piece?  Page six of six, “This page intentionally left blank”.

Well, of course, we must not allow people to just state their income, and provide no justification (seriously, there was a period there when you could make loans more or less based upon a piece of paper that said, “I totally make a hundred grand a year”).  But the problem with the response to the financial crash is not that they increased the documentation requirements for Alt-A loans.  The problem is that they increased the documentation requirements guidelines for all loans.

The Meta, Or Why This Is The Fault Of Both Parties… and Business… and the Worker.

Parties first, because it’s election season.

The first pernicious problem is that nobody wants to deal with this through the criminal courts system, which is where you should tackle this problem in the first place.

Remember: audit is a tax on the honest.  So our response to a couple of bad actors in a system is to increase the tax on the honest instead of ejecting the bad actors?  This makes sense in what Bizzaro universe?

Nobody wants to deal with this through the criminal courts system because trying to put these guys is jail is admittedly a hit-and-miss prospect.  Largely “a miss” is the outcome, and it looks bad when you go after people and don’t get convictions.  Public prosecutors are public offices, and the people who don’t want to go to jail hang out with other people at the country club.  Nobody donates cash to an attorney general’s re-election campaign when said attorney general just threw Bob in jail for 20 years for fudging books.  Geeze, it’s not like Bob murdered somebody.  His poor wife!  His kids have to go to Harvard… on scholarship!

This is where a law-and-order, classic Republican could interject and say, “Look, I don’t care if we get the guys at Goldman or not.  I don’t care if they donate a hundred thousand dollars apiece against my re-election campaign.  I’m the Attorney General of the State of New York, and some of these guys committed fraud, and somewhere there’s an email that shows that they knew it, and I’m going to find out who they are and drag them through the court system and get them on the front page of the paper and by God and all that’s holy, they may not go to jail, but they’ll never work in this industry again and nobody at Goldman is going to try this crap again for twenty years!”

Man, I wish we still had Republicans like that, instead of the sycophantic saps who raise a hue and cry about the persecution of business, and those terrible Democrats who hate America are at fault.

Or a honest, servant-of-the-people Democrat would say, “Look, I don’t care if we get the guys at Goldman or not.  I don’t care if they donate a hundred thousand dollars apiece against my re-election campaign.  I’m the Attorney General of the State of New York, and some of these guys committed fraud, and somewhere there’s an email that shows that they knew it, and I’m going to find out who they are and drag them through the court system and get them on the front page of the paper and they may not go to jail, but they’ll never work in this industry again and nobody at Goldman is going to try this crap again for twenty years!”

Man, I wish we still had Democrats like that, instead of the sycophantic saps who raise a hue and cry about how the rules just let the bad guys get away with it again, and those terrible Republicans who gut the rules are at fault.

You know who is at fault?  The AG that won’t try the case.  That’s who is at fault.

The second pernicious problem is the libertarian complaint, the “revolving door between industry and government”, which is a legitimate complaint.

This isn’t all-industries-wide, but there are some where it’s particularly bad.  This makes that first problem worse in two different ways.  First it provides yet another disincentive to just send in the FBI and serve warrants and drag people through the criminal courts system, and second it bites the hand that feeds you.  You need a job, when your period as a regulator is up.

Business next, because at the heart of it, this is really their problem.

Seriously, why do you continue to employ these people?  How is it that almost everybody – everybody – who held a position of authority at a financial corporation in 2006 is still employed?  Why aren’t these people digging ditches somewhere?  Somewhere there’s a middle manager who was screaming for two years that your CDS wasn’t worth crap and you fired the guy because, “whoooo, money!”  Why have you not rehired him at five times the money and fired the five idiots who kept saying “whoooo, money”!?  That’s an aside… sorry, I’m getting ranty.  We all know the answer, never mind.  Successful business is a sign of awesome, even went it’s built on sand.

There are people in the mortgage business whose job it is to make sure that your paperwork is correct.  They are not, however, the people who originate the loans; that’s the loan officer.  The loan officer’s job is to get the customer and get them to agree to borrow money from the company.  The people that do all the paperwork work (the processors, the underwriters, the escrow agent), they’re the ones that handle the paperwork.

But of course, the guy who gets the customer is the one who gets paid the most, and usually on commission of some sort or with a bonus structure depending upon the total dollar value of all the loans they originate.  The paper-pushers are salaried or hourly, maybe – if they’re lucky – with a yearly bonus.  So when regulators add regulation, the burden is borne by the paper-pushers.  But the economic incentives are still for the loan officer to get those loans into the system, not expedite their processing.  The last person to change behavior is the loan officer.  They are going to ignore the paperwork requirement changes and do what they did yesterday, because that’s how they get loans into the system as fast as they can.  The paperwork piles up because the processor now has to go back-and-forth with the loan officer, since the officer is the point of contact with the actual borrower.  When there is a dispute, the guy who owns the company is going to side with the rainmaker over the ditch-digger.  Yes, I know Bob screwed up again.  The loan is worth your monthly salary to the company.  Get it done.  Never mind that it takes you four times the time to do the work because Bob won’t do his job.  That’s not his real job.

It’s not just the home loan business that is like this.  In construction, safety regs are added to help the worker, but the sub-contrator’s foreman’s main job is to get 40 rooms drywalled and taped before noon on Tuesday, so that the painters can start the job, so that the customer can move in by Friday.  But the foreman didn’t sign the contract with the general contractor, that was the sales guy.  And the sales guy promised that they’d get the 40 rooms drywalled before noon, because otherwise he feared they might not get the project.  Never mind that the regs (and actual human safety) state you shouldn’t have a five man crew hoisting that much drywall without a drywall lift; we have ten guys and one of the lifts just broke and we have six hours.  Get it done.  Otherwise we’ll lose money.

I have seen this so many times, and in so many different industries, that I’m convinced that the main problem is right there.  Businesses refuse regulation because it makes their lives more complicated, but they refuse to self-police their own internal processes and most importantly remove economic incentives for people to act stupidly and add economic incentive for them to act intelligently.  Getting the contract is more important than doing the job, because the contract is the money, and the job is just work.  The bigger the organization is, the more likely it is that those two functions get decreasingly decoupled.  The further you remove “the work” from “the pay”, the worse it gets.  I really don’t have a good answer for this one, except stop structuring our economic and financial system to benefit large companies over small ones.

Hey, you know what might help with that?  Decreased regulatory burdens on small companies.  Maybe we should try and figure a way around that…

The Worker last, because this is really… really… also their problem.

The Foreman in the previous example has a job.  One of his job’s responsibilities is to take care of his team.  The other responsibility is to get the job done.  You know, it may just be the case that today, we can get that job done with that one lift
but we really need to make sure that we get that lift fixed, and really that’s my fault because I knew that lift was going to break two months ago but the owner kept refusing to buy a new one.

You know whose fault that is?  Yours.  Regardless of what your boss wants, regardless of what your position is at a company, regardless of what your strict legal duties are and your fiduciary responsibilities are, you have ethical duties to your coworkers and your employer.  One of them is to tell them when they are doing something wrong, and make it change.  If nobody ever advocates for change, it’s not going to get better.  If you can’t get it done at the place in which you work, you need to find another job where making change isn’t necessary.  Put away the Xbox controller on Friday and spend that time sending out your resume, and hope that the person who replaces you will make the Old Man Boss do the right thing, because you’re not doing it and he certainly isn’t going to do it on his own.  And when you don’t do it?  Bad things happen, and those bad things lead to those internal company rules or industry-wide regulations that annoy you about your guys always having to wear weight belts or always have a fifteen minute break every four hours or whatever your personal pet peeve is.  Your political party isn’t going to make those rules go away (see the above) nor are they going to make the bosses always do the right thing (also see above).  People used to take this sort of thing into their own hands.  Unionize.  Go over people’s heads and complain to the big boss.  Have a healthy conflict with the sales guy.  There’s lots of potential things you can do there… doing nothing isn’t your only option.

Also, vote for a real district attorney, instead of assuming that “party line” bit is going to produce a better outcome.