TOC Open Letter to Michel Barnier
copy to Jean-Paul Gauzès
Your Turn

March 30, 2010

Dear Mr Barnier,

"French officials expressed frustrations over the failure to reach a deal, suggesting that Britain was isolated on its chief concerns." Reading George Parker and Nikki Tait's dispatch about how Europe delayed an agreement on hedge fund regulations (*), one may think it all came down once more to a dogged defense of its financial industry by the United Kingdom.

That two Frenchmen, Mr Jean-Paul Gauzès, as a Member of the European Parliament, and yourself, as a European Commissioner, happen to be especially influencial in this regard may reinforce nationalistic suspicions. Yet Europe has been built from solving countless such bruising encounters.

Do not however content yourselves with finding some reasonable deal. To Anglo-Saxons natives, financial matters are not a mere question of national interest but of religion. "The truth about speculators: they are doing God's work", Paul Murphy writes in the Observatore Londinio (**). You must not rest until you win their hearts also. Focus indeed on empathizing with the common flock fleeced by the high priesthood of finance.

Rules and regulations are useless, they like to say. Clever crooks will pierce all protections. How come, from Oliver Cromwell's Ironsides to infantry deployed in Irak today, armor is still in such popular demand? Speculation is godly, they write. And truly, saving money is to take a gamble. When however they field enough resources compared to their targets, professional speculators are no worthy gamblers but sure winners by creating self-fulfilling prophecies. The market is perfectly efficient, they used to proclaim. Ahem! As Andrew Lo reminds us, "a sucker is borne every minute".

Empathizing is not enough. You must be ready to nail down a few theses. First of all, the more liquid a market, the more it must be supervised. For, like oceanic waters which so reliably reach their equilibrium level, markets can also amplify trends left unchecked to tsunamic proportions.

Second the current financial crisis started as a systemic failure of existing recommendation systems. When clients come to believe the advice of salesmen on commission, for instance to finance their municipal debt with derivatives as Vincent Boland reports from Milan (***), when companies pay officially disinterested recommenders which later find their securities spotless, you know how alluring it is to abuse such indulgences.

Third this recommendation crisis has been compounded with a responsibility crisis. Not only taxpayers had to bail out banks too big to fail and countenance their leaders' babylonian lifestyle even in retirement, but the top credit rating agencies are too indispensable to be held accountable.

Still, protesting against corruption at the top is one thing. To drive the truth home for Mr Gordon Brown, why not further write the Institutio Pecuniariae Rei. This book of finance reform is needed in order to rediscover the origins of capitalism, before capitalists obscured its simple tenets.

Capitalism is based on decentralization and while its very success creates growth, such growth must be carefully monitored at every scale, whether in a single organization, between colluding allies, within a specific industry, all the way to society trends. Not that success is a mark of evil, an heretical thought, but because too much growth cannot fail to threaten decentralization, a lesson born from practical experience.

Indeed the hedge funds industry should feel honored by your being intent on regulating them. It seals their success. Gripe they may, they are punished even though they were not the prime engine behind the crisis. The best medicine is preventive and, had your book been available two years ago, maybe the Competition Commissioner too would have felt justified to check Google's exuberant growth before it became malignant.

But your Institutio must examine how markets themselves can destroy the decentralization they are meant to implement. First the more decentralized a market, the more power to the market organizer, as a privileged observer, and the greater the temptation to turn it to selfish advantage. Second the freer the market, the greater its liquidity but, once again, the easier for speculators to mob potential targets by orchestrating a rush to the exit by those tied to them in any way. Third the faster transactions are mediated by markets, the harder it is for any benevolent human observer to intervene.

Good markets create information but, without a clear data rights doctrine, such useful signals get either lost or misappropriated. Good markets facilitate transactions but, without appropriate built-in dampening structures, runaway speculation ends up in value destruction. Perhaps finding such remedies is a tall order. But why should cultural goods markets be the only ones amenable to stringent built-in controls? Enlist Amazon for help.

Capitalism is also based on the predictability which proceeds from the rule of the law. Such predictability acts in the same way as an insurance policy. Neither precludes catastrophes, nor are they free. Yet they both generates confidence, and on this faith alone can a market thrives.

Do rules burden innovators? In the instance, Patrick Jenkins explains that "as regulators seek to make the financial sector safer, they are also insulating it from fresh competition" by increasing barriers to entry (****). Still, despite this well known trade-off between safety and competition, who would eliminate physician licensing and medical drug trials in a bid to drive down healthcare costs?

The more you assert your right to rule and burden financial institutions with associated costs, the humbler you must become. Not because your public stewardship deprives you of the competent acumen of for profit actors. Can you do worse than AIG? But, as current guns call for better armor, so better guns appear to best it. It is this self-conscious self-adaptation of economic agents which requires your perpetual vigilance.

Last capitalism is based on the ability to limit one's financial risk. It has now been twisted into the capacity to multiply one's neighbors' financial risks, a devilish achievement. Your Institutio will do well to review the validity of recommenders' business models and restore their responsibility.

But what about the casuistry of modern accounting? Francesco Guerrera, Henny Sender and Patrick Jenkins' article about the use of "Repo 105" by Lehman Brothers is titled "Damning light into inner workings forces Wall St to search its conscience" (*****). For Gillian Tett (******), Wall St is more likely to search for a foreign legal firm as accommodating as Linklaters, the UK director of conscience too happy to oblige rich penitents.

While justice will be brought to bear on those who signed off on figures too good to be true, the best way to attack sin is to remove temptation. Why not limit take-home pay of all financial stars to some earthly multiple of entry level clerks? Hold the excess income, be it salaries, bonus, options, shares, pensions and perks, into some capital account and use it to meet any unpaid corporate liability till collective responsibility tails off.

Kept tax neutral, this scheme does not scapegoat any occupation nor does it limit the freedom of compensation packages. Rather, by imposing continence on all beneficiaries for the duration of the liabilities underlying their compensations, it lowers the risks associated with corporate leverage. Lest lost souls quickly unload liabilities to naive third parties, as with originators of 30 year mortgage and derivatives thereof, attach a permanent liability to the special capital account of any one time handler of the financial instrument concerned, to be called in historical order of handling (1).

Individuals concerned may complain this scheme would raise their own risks. Actually the latter would remain limited to the cumulative excess in their compensation. As this amounts to a disguised transfer of capital, it is normal it bear the same risk as ordinary long term shareholders.

Perhaps meditating on your Institutio will hold less appeal for Mr David Cameron, who appears preordained to be the next British Prime Minister. Were he to succeed and face a parlous treasury, such a true blooded tory may still welcome your call for regulatory oversight. Isn't it reason enough to take over the assets heaped in houses exposed as doing God's work in the lap of luxury, while great lords and common folk alike go wanting?

With my sincerest regards for your zeal and fervent prayers for your success.

Philippe Coueignoux

PS: Some Anglo-Saxons voice similar calls to reform, as David Leonhardt making "the case for more - and more nuanced - regulation" (*******).

  • (*) .............. Brown wins delay on hedge fund vote, by George Parker and Nikki Tait (Financial Times) - March 17, 2010
  • (**) ............ The truth about speculators: they are doing God's work, by Paul Murphy (Financial Times) - March 13, 2010
  • (***) ......... Banks face fraud trail in Milan over sales of derivatives, by Vincent Boland (Financial Times) - March 18, 2010
  • (****) ....... Outsized risk and regulation inhibits entrants, by Patrick Jenkins (Financial Times) - March 24, 2010
  • (*****) ..... Damning light into inner workings forces Wall St to search its conscience,
    .................... by Francesco Guerrera, Henny Sender and Patrick Jenkins (Financial Times) - March 13, 2010
  • (******) ... Global harmony a distant prospect despite Lehman outrage, by Gillian Tett (Financial Times) - March 16, 2010
  • (*******) . Heading Off the Next Financial Crisis, by David Leonhardt (the New York Times Magazine) - March 28, 2010
  • (1) hidden risks being long term, measures calling for a 3 year delay on some forms of compensation make for symbolic slaps rather than real feedback loops
March 2010
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