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America’s Regulation/Supervision Paradox

When it comes to financial markets, why is supervision as crucial as regulation – if not more so?

April 21, 2010

When it comes to financial markets, why is supervision as crucial as regulation - if not more so?

In the ultimate analysis, the quality of a financial system comes down to two simple rules: First, it is only as good as those who monitor its practices, styles and traditions. And second, these individuals must be empowered and determined to ensure that certain rules are followed.

In a word, it's mostly about supervision — and not so much about regulation. A culture that fails on the supervisory front cannot save itself by enacting more rules.

How is it then possible that the United States — the very country which invented the bureaucratic, deeply resourced mega-corporation and staffed its government in a similar fashion — should fail in accomplishing this task?

That is indeed a question that has puzzled many smart people outside the United States for some time. The likely answer to this seeming riddle has six components.

First: Overstaffing

In any bureaucratic entity, there comes a point when the internal complexity is such that a smoothly functioning management of decision-making processes is no longer possible. The intra- and inter-agency coordination process in the United States — with the budget-wasting addition of tens of thousands of government contractors and consultants — has taken on gigantic proportions. Ironically, the latter expansion was mostly a Republican president’s doing (George W. Bush).

Second: Vilification

Governments, like all humans, do make mistakes — and they do so the world over. But it seems a peculiar American blood sport to vilify and denigrate civil servants who, in reality, are overwhelmingly well-intentioned and often quite high-performing.

It is as revealing as it is astonishing to find frequent references to government bureaucrats(!), not civil servants or government employees – without any quotation marks, mind you – in the reported pages of major U.S. newspapers.

Third: Culture of accommodation

Contrary to the perception of an overly rigorous, rule-bound U.S. bureaucratic system, wherever real tough business interests collide, U.S. civil servants tend to be quite, if not very, accommodating — at least when compared to virtually all of their international counterparts in the OECD area.

The reason for this accommodativeness is rooted in the relatively low status which civil servants maintain in the United States. By and large, they are regarded as basically akin to soldiers in Western European societies (“We know we need to have some of them around, but preferably none in my own social company”).

Fourth: More money corrupts

The large U.S. banks were also able to run roughshod over many existing regulations because the civil servants or public appointees engaged in a game of chicken, but for an ultimate personal payoff. In their desire to please those with the real money, they sought to signal their adaptability by not standing in the way of the powers that be.

Whether it was Alan Greenspan or a bank examiner who is hoping to get a better-paying job on the compliance side of Citigroup or Bank of America soon, they showed little backbone. After all, the money offered by the real “players” to those who switched over to the corporate sector was just too juicy.

Fifth: Indecision

U.S. culture, viewed from the outside, has a strong reputation as being decision-oriented. In reality, however, that sense of strong determination is quite off the mark.

Alan Greenspan, the iconic U.S. Fed chairman held in high regard for far too long, understood this superbly – and disastrously. It is mostly about going along to get along. And it's about never standing in the way of the winning ways of “Team America.” After all, if “we” lead the world in finance, we have to do what it takes to defend our role — even if that means playing loose with the rules.

Sixth: Outsourcing

Getting private businesses involved in many federal affairs was primarily the philosophy of the George W. Bush Administration, which ran the country for much of the past decade.

Ideology aside, it had a very real reason to pursue that approach. After all, apart from health care, government outsourcing was pretty much the only reliable job engine during its years in office (2000-2008).

Of course, the more troublesome consequence of its overall approach was that it made the existing ills in the U.S. government process much worse. Corporations, keen on getting business from government, perversely had a compelling reason to badmouth civil servants (aka government “bureaucrats”).

Using that pejorative made it clear to all why more outsourcing of federal functions to private-sector companies was needed. Never mind that it further added to the over-complexity of the process. If something went wrong with this outsourcing strategy, not to worry. On can always blame the “bureaucrats” for errors committed by private firms.

Any solution in sight?

In the end, the only way out is to supervise more — more determinedly, even more ruthlessly, with the head held high and smaller staffing numbers.

Capitalism whithers if there is not enough push-back against all the rule breakers and underminers.


Capitalism whithers if there is not enough push-back against the rule breakers and underminers.

A culture that fails on the supervisory front cannot save itself by enacting more rules.