Don’t bet on the regulators, Arnold Kling says, in the OODA loop contest with financial traders — who are always a step ahead, Corine Hegland explains:
The transactions that turned some stupendously bad loans into a global calamity were designed to thread loopholes in the very regulatory, accounting, and legal regimes set up to prevent such things. Indeed, this is what bankers and financial traders always do, because they make a great deal of money from it. They call it arbitrage. In currency markets, arbitrageurs are constantly buying and selling currencies across borders to make money on small price fluctuations between dollars and yen, or euros and renminbi, for example. In “regulatory arbitrage,” the bankers and traders restructure transactions to take advantage of differing rules, and hence prices for risk, for various kinds of regulated financial products. It’s very hard — maybe impossible — for regulatory bodies to keep up with the arbitrageurs.“The institutions are always ahead of the regulators,” said Kevin Jacques, who spent 14 years at Treasury before joining the faculty of Baldwin-Wallace College in Ohio. “Whenever you fix a problem, you create an unintended consequence whereby you’ve just said to financial institutions, ‘OK, go out and figure out how you’re going to alter your portfolios.’ You’re fighting against yourself.”
The only novel aspect to this particular cat-and-mouse round is that the ruthlessly efficient financial markets stayed ahead of regulators long enough to swell Americans’ household debt to nearly 100 percent of U.S. gross domestic product, a feat accomplished only once before, in 1929. If regulators don’t come up with a game-changer of their own as they address the current crisis, the markets will win the next round as well. Careful regulatory alterations take years, but financial institutions adapt within months.