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Regulators are people too

By Daniel M. Ryan
web posted July 20, 2009

Religious people have had to endure various unflattering characterizations: one of the standard digs claims that a believer is an overgrown child. Purportedly, God is just a father figure for people who can't or won't grow up fully. A more mature perspective on religion, so the line goes, involves seeing it as a mere cultural institution.

What's odd about this line, well beloved by liberals, is the pot-calling-the-kettle-black aspect of it. In more worldly matters, many of those same people display a childlike credulity towards regulators and regulations. "Regulations make us safe," many of them claim – implying that if we all follow extant regulations blindly, nothing will go wrong unless there's an unnoticed hole for the regulators to fill. This escape clause keeps that claim from being reality-tested, and does set up pressure for more regulation to be applied by rote.

To claim that God is merely an abstractified human being is an argument. To claim that regulators are merely human, though, is a case that rests on provable fact. All regulators are human; I know of no aliens or supermen employed by government bureaus. They do make mistakes, some of which follow definite patterns. The same point applies to regulation promulgators. All of them are human; some of them make mistakes. To recognize this fact is simply part of growing up. A naïf who takes the above critique of religion to heart would assume precisely the same with respect to regulations.

How To Thrive In A Regulated State: A Crook's Guide

The word "cunning" is underused today. A cunning person is someone who comes up with a perfect con – one that bamboozles 'em coming and going. What better con for our times than "of course we're above-board – we're regulated"? What better way to bilk the public than to claim that any illegitimate business would ipso facto be regulated out of existence?

Of course, regulators are trained to spot such people; so we assume. A crook, however, is someone who knows how to spot and exploit human weaknesses. We also assume that such crooks confine themselves to exploiting customers: that they exist in a shadow land in which they hope they'll never be spotted by a regulator. It's a comforting thought, and even takes away the pain of standing on one's own judgment, but this behavior pattern only described the simple con artist. The more sophisticated breed con the regulators too.

Case in point: Bernie Madoff. Not only was his Ponzi scheme conducted in a regulated industry, the regulators knew of him.In fact, his son-in-law was an SEC employee. If crooks require a shadowy underworld to con people, then a Madoff should not have existed.

He evidently has had many imitators. If there be a god of the fates, (s)he would be smiling ironically over the fact that such a heavily regulated industry would have spawned so many Ponzi schemes…which were criminalized before the SEC even existed. There's no way that "lack of regulation" could have provided a loophole for a plain Ponzi scheme: Ponzi himself was successfully prosecuted for his own in the 1920s.

Could it be that the SEC was asleep at the switch? If so, why? Few people have advanced the obvious reason: con artists are accomplished at conning people. Regulators are people, and have blind spots too. Just as con artists exploit people's blind spots to defraud, so they exploit regulators' blind spots to avoid getting caught.

In a regulated industry, a con man's dream consists of having anyone who knows the real score viewed as a "crank." Regulators, as well as the police, do receive false and frivolous complaints. The fact that false accusations are criminalized themselves is mute testimony to the fact that some like to use the criminal justice system to pursue vendettas. Prisons are full of inmate plaints about how the "real criminals" did them in. Had false accusations not been screened out, how many of them would escalate from griping to vengeance-seeking?

So, it should be no surprise that all prosecutorial authorities have hard-won methods to sift out genuine complaints from false ones. Although this trick is difficult, a con artist has it made if (s)he can convince the relevant authorities that a true complaint seems false. For all I know, Bernie Madoff used the "they're just jealous" line. If so, he used it because it works. Many false and frivolous complaints are prompted by mere jealousy or rancor.

This flaw – an inevitable one, really – is not confined to the investment industry by any means. Another industry that attracts the cunning is day care…regulated day-care. Yes, day care that's been regulated enough, or to the point where the regulators have to use rules of thumb. If the regulations have grown too voluminous to completely enforce, a conscientious regulator has no choice.

The Regulatory Fix

If there's any governmental analog to the so-called "technological fix," it would have to be the regulatory fix. Something went wrong? Enact another slew of regulations. That's the fix.

As long as the regulatory fix is standard procedure, enforcement will always be a Red Queen's Race. All proposals for bigger budgets for better enforcement assume that the current slew of regulations will not be expanded. If they are, then what happens to the budget increase?  Especially if the new regulations are enacted with a spate of post-scandal publicity?

As long as there are cunning people, there will never be an ideal set of regulations. The only way to theoretically make an industry crook-free is to ban it entirely. Even this method fails to work, as the drug-dealer network plainly shows.

There's only one way out of this dilemma: skepticism. Thinking for yourself. Trusting yourself. Shying away when something seems odd.

Of course, this attitude matters little if we don't know what to look out for. Given that con artists can con anybody, perhaps the best remedy is a guide explaining when to say "never." Doing so, though, would require a mature attitude towards regulators that begins with dropping the notion that regulators are all-wise father figures.

Just as maturity in self-defense begins with the realization that the police don't have a magic teleporter, which can beam them to a crime scene to prevent the crime from taking place. ESR

Daniel M. Ryan blogs these days about low P/E stocks.


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