Monday, June 29, 2009

A Libretto for the Upcoming Legislative Changes

There is an old saying that goes “No man’s life, liberty or property are safe while the legislature is in session”. Recently we’ve been treated to a great example of this as the Obama administration introduced its proposals to overhaul the regulation of the financial industry and is revisiting a version of national mandates on health care. This being a blog on investor relations, I will focus on the process of changing the regulations in the financial industry, as eventually those of us involved in the equity markets will be impacted by such changes. Most aspects of the regulatory apparatus that oversees the financial industry, from the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Federal Reserve, the Federal Deposit Insurance Corporation the Comptroller of the Currency and various and sundry other regulators have come under scrutiny. Nobody really knows how all of this will play out yet, but it makes great theatre, so I thought I would give everyone a guide to the proceedings.

Act One, Scene One: Capitalists will seek an investment edge that will allow them to reap profits. Once they find one that is legal, the early movers will become very rich. They will be followed by many more capitalists who, seeing the profits to be made, will expand the pool of money available for the investment in question. As more money chases a finite number of investments, standards will be lowered. See for example, the funding of start-ups in the dot .com boom, the prices paid for private equity deals in early 2008 and the sub-prime housing lending bubble. Eventually, when prices get crazy enough, the whole bubble collapses under its own weight. Investors lose tons of money. Everybody blames someone else for the collapse. There are outraged calls for Congress to act.

Act One, Scene Two: Enter the politicians and the bureaucrats. Sensing an opportunity to score easy points with the public, politicians begin to make proposals to protect investors, consumers or anyone else that can vote. After all, people vote, corporations don’t. The legislation that is proposed is designed to fix the immediate problem on hand and to demonstrate that Congress can act. Press conferences are held, laying out bold new initiatives to protect investors and consumers. Hearings are held, wherein the scapegoat du juor gets publicly flayed. While the politicians are preparing to act, the bureaucrats swing into action. This is where bureaucratic empires can be won or lost. Witness the recent struggles between the SEC and the CFTC. While it might make sense for one agency to regulate both securities and the derivatives that trade off them, neither the SEC nor the CFTC was going to submit to the other. Influence is wielded to protect regulatory turf and deals are cut.

Act One, Scene Three: Congress drafts legislation. In fact, they draft multiple versions of legislation. Nothing makes a Congressman or Senator feel better than to cosponsor legislation that will help them demonstrate to the folks back home that they are helping stamp out the evils of the flawed financial system that allows poor hapless consumers and investors to be sucked dry by rich bankers and hedge fund managers. Nobody pays any attention to the additional regulatory costs being layered onto the system. After all, corporations will pay that, and corporations don’t vote.

Act Two, Scene One: As the legislative process heats up, the fabled lobbying system swings into action. Lobbyists work on three basic premises: 1.) Time is their friend. The longer legislation can be delayed, the better the chance provisions can be inserted into it that benefit their organization. 2.) Every corporation resides in a home district or state of some Congressman or Senator and those corporations control jobs and investment spending in somebody’s home town, and those people do vote. 3.) While corporations don’t vote, their trade organizations control lots of money. And money is the mother’s milk of politics.

Act Two, Scene Two: Legislation finally gets passed. The President holds a bill signing ceremony and smiling legislators gather around him. The system works, sort of. The bill that gets enacted is usually far too long, with conflicting provisions and a very unclear legislative history. It will inevitably prove to have unintended consequences that will later require further legislative or regulatory fixes. Lawyers representing constituencies whose oxen are getting gored by the legislation are preparing to file lawsuits challenging the law even as the President is signing the bill.

Act Two, Scene Three: Capitalists begin combing through the legislation seeking an investment edge that will allow them to reap profits…

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