Streetwise Professor

December 20, 2011

Don’t Let the Door Hit You on the Way Out, Barney*

Filed under: Derivatives,Economics,Financial Crisis II,Politics,Regulation — The Professor @ 9:54 am

Retiring Congressman Barney Frank, the Frank of Frankendodd, felt compelled to share some parting wisdom on whether in the aftermath of MF Global it was appropriate for the CME to exercise self-regulatory powers:

“I have no doubt about the CME’s integrity, but nobody should be in the position of having a dual role,” Rep. Frank said. “We should make sure [a conflict of interest] doesn’t arise, that the temptation isn’t there, that people are not unconsciously influenced

. . . .

Rep. Frank pointed to the separation of the Nasdaq Stock Market, now owned by Nasdaq OMX Group Inc., from the National Association of Securities Dealers.

That process began in 2000 and saw the NASD become a full-time regulatory body now known as the Financial Industry Regulatory Authority, or Finra. Part of the rationale of that move was to separate the regulatory function from a for-profit exchange operation.

“I think it would be better if they did what NASD did,” Rep. Frank said.

He said that.  He really did.  He held up Finra–the Finra that couldn’t find Madoff and Stanford with a map and both hands–as the model to emulate.  Seriously.

Of course the Finra (or government regulation) models are superior because the people who work for them are saintly, and never subject to temptation.  They are never subconsciously influenced.  They are Spock-like creatures, incapable of being captured, influenced, or duped.

And they have the best information and the strongest incentives.

Sure they do.

As I said in my weekend post, perfection is not an option here.  A serious analysis of incentives and information is required.  And of course, as I said in that post, Barney Frank doesn’t provide any serious analysis.  His is the epitome of Beltway superficiality: he invokes “conflict of interest” as if that is the only relevant consideration, and cites some example that is ridiculous on its face.

And he doesn’t get called on it.

Would somebody please–please–ask the man a serious question in response to such bleatings?  Would somebody please  challenge him on the Finra lunacy?

* Because doors are expensive.  Note: click on the link only if you have a strong stomach.

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  1. Live long and prosper, Prof.

    All the best of the holidays to you and yours.

    Comment by markets.aurelius — December 20, 2011 @ 10:13 am

  2. Thanks, markets (or do you prefer aurelius 🙂 ?) Trying my hardest to achieve both. Same to you. Have a great holiday season.

    The ProfessorComment by The Professor — December 20, 2011 @ 1:44 pm

  3. The idea of even contemplating Barney Frank before 8 am Eastern time is sickening, but let’s give it a try: non profits are good because government influence can be magnified. it is generally harder to screw with a profitable, for profit firm that has a large base of well to do, influential stockholders that know what they are doing than with a mutuality with an atomized control function (i.e. a small set of cronies who usually run things entirely for their own benefit).

    This was seen a lot in the thrift industry before and during the disintermediation crisis of the 1980’s, where NY mutualities were sometimes hotbeds of cronyism and political hackery. Massachusetts was far, far worse – particularly under Dukakis. In the case of the Frankster and Iron Mike Dukakis- they were buds with a former Alex Brown Partner Carmen Illio. Illio was a nice kind of guy, but definitely from the (not Wall) street. How a guy like him became an Alex Brown Partner in the early 80’s gives you some idea of the power and profit making potential this buy had: I doubt he would be invited to many of the other partners’ homes.

    Illio was on the board of the outfit that controlled all the towns’ combined pension funds during the 1982-1988 bank conversion boom, flipped a lot of stocks between funds, and eventually en-slammed at club fed for bank fraud. No charges were ever proven vis a vis the funds – Surprise! – that could have taken down a lot of bipartisan partisans in the Bay state. Beforehand, however, he was a great source of money and influence in the democratic party, and a lot of people made money off of him. The bank conversion boom was a kind of one shot deal: a number of people later realized it would have been much better to keep the old place going under the old rules without a lot of outsiders messing things up. The mutual ownership model is almost finished in finance, excepting insurers and credit unions, still ripe sources of local patronage. If you don’t believe me look at the history during 1989 – 1992 of the Rhode Island state credit union industry to see how bad things can get. Not for profit or mutualities equal pull for the insiders, whether they have money or not.

    Of course Barney loves not for profits – it means more power for himself and like minded political-social pond scum.

    As Barney would say Merry Christmas to all, where politically correct and expedient to do so!

    Comment by Sotos — December 21, 2011 @ 7:11 am

  4. I clicked on the link MY EYES!! This man gives the morbidly obese (like me) a bad image.

    Comment by Sotos — December 21, 2011 @ 11:36 am

  5. @Sotos. Very interesting. I always laugh whenever I hear OWS types laud credit unions and mutual financials as being paragons of financial virtue, untainted by corruption. The economic theory of non-profits says that under some circumstances, low power incentives can be a good thing. But those circumstances are quite limited. Moreover, these things don’t scale well, and are not subject to capital market discipline. Which, as you point out so well, is a feature from the perspective of Barney et al.

    WRT to exchanges specifically, I wrote a paper that was published in 2000 that showed that non-profit form served a very different kind of function than is the case for most other non-profits. It was an artifact of floor trading technology, and the resulting heterogeneity of membership. A for-profit exchange would have tended to redistribute wealth from the more efficient/profitable members to the marginal ones. The non-distribution constraint of the non-profit form prevented this sort of redistribution. The paper was written in 96-99, with various revisions, tinkering, etc., and one of the predictions that emerged early in this process was that electronic exchanges should be organized as for-profits. That prediction was borne out in very short order in the late-90s early-00s.

    But insofar as Franks’s point is concerned, self-regulation was totally peripheral in its effect on the evolution of ownership form. That was driven by the factors I just mentioned. And as an even earlier paper in the JLE showed, exchanges–especially non-profit ones–have lousy incentives to discipline some forms of bad conduct, notably manipulation. It is incentives that matter. Exchanges internalize some of the costs and benefits of some forms of bad conduct, and hence have an incentive to police it. They don’t internalize the costs and benefits of other forms of conduct nearly so much.

    The whole “conflict of interest” thing is just intellectual laziness. Yeah, sometimes it matters. But stopping there, and ignoring the huge incentive problems that non-profit enforcers often have, is just a cop out.

    In closing, speaking of Barney and Christmas–we now know what he needs. A bra. From the plus size store.

    The ProfessorComment by The Professor — December 21, 2011 @ 12:36 pm

  6. […] will be good only because Barney Frank is retiring. Dodd-Frank is one of the worst laws in […]

    Pingback by Monday Morning Breakfast Links | Points and Figures — December 26, 2011 @ 6:48 am

  7. Just in case you missed this candid interview of a buffoon, and his righteous perspective of his importance.

    Comment by scott — January 18, 2012 @ 4:51 pm

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