Harry Markoplos is one of my heros because of the courageous work that he did exposing Bernie Madoff. I couldn't resist watching a recent CSPAN interview even though I hade seen most of the material previously. The interview illuminated an important lesson that has not been well studied.
Markopolos believes that diversification and better financial regulation are the keys to eliminating future financial system upsets. He is wrong about the effectiveness of "improved" financial regulation. That is odd, because his book exposes the indifference of the SEC and the CFTC to the subprime crisis. We have 40 years of evidence that prove that financial regulation is UTTERLY WORTHLESS. When the chips are down and fraud is rampant, don't count on the FSLIC, FDIC, SEC, Federal Rerserve, or the Congress. They oversaw the Savings and Loan meltdown of the 80s; the tech bubble of the 90's; the mortgage bubble; and the subprime crisis. They didn't "discover" any of these problems until they blew up. On the contrary, they largely encouraged them. They were UTTERLY WORTHLESS.
All of these financial failures collapsed under their own weight with help of a few individuals and financial speculators. Financial regulators, in many respects, enabled and enlarged the problems. In their role as protector of the public and the taxpayer...they were UTTERLY WORTHLESS.
The proposed financial reform is really a red herring. It deflects attention from the politicians that are fully culpable in these crises and shifts attention to a few big private miscreants. Will the new regs work? They will for quite awhile, because the public is so badly burned that they trust no one. The cost will be high. Regulations, taxes, fees, extra accounting and mis-allocation of resources will all take their toll. Politicians will preen in front of TV cameras and gather a lot of campaign contributions.
Is there a better way? Like most of our current issues, this one could be solved with a pencil, piece of paper and no taxpayer money. The current FDIC insurance of deposits encourages deposits at the worst institutions because they pay the highest interest rates. Worse, depositors are indifferent to the risk because deposits and accrued interest are fully insured. Change the law so that public insurance covers just 95% of deposits. Depositors will pay attention, and bad practices will be exposed much sooner. The insurance will be strong enough to prevent depositors from going broke, but they will no longer be indifferent to the risk to their money.