Edward J. Waitzer is professor, Jarislowsky Dimma Mooney Chair and director of the Hennick Centre for Business and Law, Osgoode Hall Law School and Schulich School of Business. He is senior partner at Stikeman Elliott LLP.
Financial regulators are beginning to assess the unintended consequences of the vast array of regulations adopted in response to the global financial crisis. Some are questioning whether rules designed to create safer markets have made them less functional.
Senior representatives of the U.S. Federal Reserve and Treasury have recently acknowledged the role of new regulations in increasing market volatility, "de-risking" (i.e., large global banks no longer serving whole classes of clients) and in the shift of activities into more opaque parts of the financial system outside of the traditional regulatory framework.
An implicit premise in much of the current regulatory framework is the notion that markets fail because of individual culprits (and that stable markets can be achieved by weeding out the bad actors). This fairy-tale construct (in which every story has a hero, a villain and a victim) feeds a disconnect between our regulatory agenda and public confidence in the financial sector. We seem to be in a vicious cycle, where the aggressive focus of regulators on the "villains" contributes to a public perception that the financial sector is full of them. This approach has been overworked and may be out of date and destructive.
The other disconnect that needs to be addressed is between the financial sector and the real economy. An underlying reality is that financial markets have changed. While once the critical mechanism for allocating capital to its most productive uses, the focus on generating wealth has shifted to rearranging it. Growing volumes once offered stability; now, they facilitate manic reactions to global events. Under the banners of "risk management" and "arbitrage," markets have become a continuing referendum on global fears and trends.
As Bill Gross of Janus Capital Group recently observed, "our global, credit-based economic system appears to be in the process of evolving from a production-oriented model to one which recycles finance for the benefit of financiers." The resulting "hyperliquidity" has added volume that tends to exacerbate, rather than dampen, swings in market sentiment. We need to re-examine the job we want capital markets to perform.
The current regulatory framework isn't designed to address these challenges. Recent failures have often lacked identifiable culprits. For all the talk about institutions being "too big to fail," the underlying reality is that financial markets themselves are too big to fail. The time has come to focus on the role of markets themselves in mobilizing and allocating capital and risk and ensure that they are working to serve public purposes by contributing to sustainable prosperity. Instead of regulating who is allowed to do what, it may be time to consider what will be allowed.
For example, where do we draw the line between risk management and open speculation? If there are activities that endanger markets, should their purpose and use be reconsidered? In addition to regulating the market conduct of securities "professionals," might we be better off mandating that the portion of savings that will be required to provide for retirement income security be allocated to simple, low-cost, financial products (unless an individual takes steps to opt out and invest otherwise)? Should regulators be actively promoting the development of new financial products and services which demonstrably meet social needs?
In 1792, two dozen stock brokers signed an agreement under a buttonwood tree on Wall Street to form what is now called the New York Stock Exchange. Perhaps the time has come to undertake an exercise similar to the now historic Buttonwood Agreement – a discussion about our vision of financial markets and their utility. This may help us step out of the existing regulatory paradigm, as well as identify the extraordinary opportunities for financial products, services and markets to better meet social needs. It may also help shift public sentiment from individual and institutional culprits to some of the more systemic challenges facing us.