The rush to reregulate the financial markets after the financial crisis understandably has many concerned about unintended consequences. Regardless of good intentions, the fixes put in place by legislators, central bankers, and regulators no matter how well thought out are bound to affect the complex and constantly evolving global financial markets in unanticipated ways. Professor Roberta Romano of the Yale Law School shares these worries and proposes in her latest paper, Regulating in the Dark, a mechanism for addressing and remediating the inevitable unintended consequences of hasty financial regulation.
Romano believes that the conditions under which financial regulations are imposed are often not ideal for effective outcomes:
Foundational financial legislation is typically adopted in the midst or aftermath of financial crises, when an informed understanding of the causes of the crisis is not yet available. Moreover, financial institutions operate in a dynamic environment of considerable uncertainty, such that legislation enacted even under the best of circumstances can have perverse unintended consequences, and regulatory requirements correct for an initial set of conditions can become inappropriate as economic and technological circumstances change.
Romano also believes perhaps correctly that the US political system does not make it easy to fix regulatory errors going forward.
[T]he stickiness of the status quo in the U.S. political system renders it difficult to revise legislation, even though there may be a consensus to do so.
Consequently, Romano's paper suggests a mechanism that can be written into legislation allowing or requiring a periodic look back at new regulations, as well as waivers and regulatory discretion methods by which experimental regulatory measures may be road tested.
(1) a requirement of automatic subsequent review and reconsideration of the legislative and regulatory decisions at some future point in time; and
(2) regulatory exemptive or waiver powers, that encourage, where feasible, small scale experimentation, as well as flexibility in implementation.
Romano's paper examines in detail how these two simple mechanisms may greatly improve the regulatory apparatus of the financial markets.
Both procedural devices will better inform and calibrate the regulatory apparatus, and could thereby mitigate, at least on the margin, the unintended errors which will invariably accompany financial legislation and rulemaking originating in a crisis. Given the centrality of financial institutions and markets to economic growth and societal well-being, it is exceedingly important for legislators acting in a financial crisis with the best of intentions, to not make matters worse.
The full text of Romano's paper may be found at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1974148