Principles based regulation

Arnold Kling believes that we should move to principles based regulation (PBR), which Sonic Charmer correctly dubs Yglesiocracy.

Kling’s mistake should be evident immediately to careful readers of this blog. Here’s his explanation of PBR:

With PBR, legislation would lay out broad but well-defined principles that businesses are expected to follow. Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines. Finally, the Department of Justice would prosecute corporate leaders who flagrantly violate principles or who are negligent in ensuring compliance with those principles.

Where would this "legislation" he speaks of come from?

If you answer from the "administrative agencies" that would provide the judicial and executive functions as well, consider yourself educated on the workings of modern government.

(The Department of Justice is a canard in this argument, if regulated entities violate regulations, regulators have no need of assistance from DOJ to enforce their own regulations).

In a sense, all modern laws are principles-based, in that agencies now act as de facto judiciary, executive and legislator. When you write laws, interpret those laws, and enforce those laws, your whims are basically the laws. Specific conditions that are written into "laws" (i.e. regulations) are actually the only things that bind regulators.

Kling is attempting to solve an important problem (at least I think he is based on other things he’s written) – the problem of regulatory arbitrage. In modern government, regulatory arbitrage arises only when regulators are sympathetic to those they regulate. In other words, there are situations in which regulators want to be arbitraged. However, giving more flexibility to regulators via PBR isn’t going to solve the problem, it’s going to make it worse.


5 Responses to Principles based regulation

  1. Toddy Cat says:

    Kling’s proposal is essentially a call for administrative totalitarianism. Admittedly, that’s about what we have now, but still…

    • asdf says:

      “In other words, there are situations in which regulators want to be arbitraged.”

      Giving regulators more power will simply move things in the directions regulators want. If they want to crack down on companies, more power will help. If they want to help them get around congresses dumb laws, more power will help.

      In terms of making regulators actually want to regulate, you’ve have to examine the incentives of regulators. All I have to say is that paying a banking regulator 20% of what he can make privately is a good formula for regulatory capture. Though there are of course many other factors.

  2. asdf says:

    Q: “Why Is Everyone So Down On The Rule Of Law?”

    A: The “law” is written by rich, powerful, connected insiders via lobbying which allows them to fill it with loopholes that make it easy to violate the spirit of the law while remaining technically legal.

    Most of my time in IB and insurance involved:
    “Well, this is a ripoff and regulation X is supposed to stop it, but there is a loophole and we are going to exploit it.”

    When the inevitable blowup happens, rather then throwing these people in jail they simply hide behind the letter of the law, keep their bonuses, and run off to the next company to run some new scam.

    “Who’s to say that consumer ‘has no chance’ of benefiting from checking their credit record. Just because their limit on that card is $200? But so? Maybe their credit will improve – maybe its being $200 is a result of a mistake and checking their credit record will help – etc. I don’t necessarily think it’s great that a card company would try to push-market this sort of thing, but you can always just say no, and if it really bothered me, I’d cancel the card and switch to some other company. Why does the consumer need ‘protection’ from anything here in the first place?”

    It probably won’t improve. They are probably a dumb hick with a sub 100 IQ that isn’t capable of understanding his options very well and are easy to sell. Eve if that’s false there are lots of cheaper alternatives to fix that. We know that’s true because entire industries exist to exploit these people and they are very profitable. It’s not a theory, it’s the real world.

    It’s a net benefit to society to just say no. More people benefit that lose from such a policy.

    The reason financial services are different from chia pets is its easy to understand whether a financial product is good for someone and hard to understand if a chia pet is good. Chia pets are subject to a wildly varying utility value from person to person. Money is money. Everyone wants more of it. A financial product that returns 30 cents on the dollar while doing virtually nothing else is a bad product. Full stop. End of story.

    “But that works in part because the ‘principles’ in question are themselves so well-defined that there is broad background societal and historical agreement about what they mean; they rise above ‘principles’ and connote specific acts that are reasonably well-understood by all in advance.”

    We can do that. Ayn Rand wierdos like you won’t let it happen, because you can’t even agree that a $60 charge on a $200 credit limit falls into that category. You go into fraud, but any attempt to prosecute the massive fraud in the housing mess and you throw a cannip.

  3. Phlebas says:

    With PBR, legislation would lay out broad but well-defined principles

    I wonder whether Kling could taboo the words “broad” and “well-defined” in order to elaborate on this notion? Because broad human principles and values in general are anything but easily defined (this is what makes the FAI problem so difficult).

    He defines one suitable principle thus: “I would articulate that principle as saying that no business should sell a consumer a product knowing that the consumer has no chance of benefiting from that product”.

    Elsewhere he says that: “Regulated industries are always ready to complain about the cost of complying with bright-line regulations. However, I have the opposite objection. Particularly when it comes to the financial sector, compliance with BLR is far too easy. The bankers are always able to outmaneuver the regulators, staying within the letter of the rules while mocking their spirit.”

    Let’s take as a highly visible illustration of following rules and breaking their spirit, Formula 1 technical regulations – because this notion is nowadays central to the inculcation of an optimal level of competition, and maintaining safety in the racing series. This year’s major within-rules-but-not-spirit innovation is the incredibly innovative “W-duct” on the Mercedes car. But in general, the cars are very similar – it takes the concerted effort of brilliant engineers to exploit the tiny loopholes in the regulations, which are very much of a “bright-line” nature.

    Now imagine that the regulations were changed to remove all of the technical specifications, and just said “build a car that isn’t dangerous, doesn’t aid the driver too much, isn’t too wide and doesn’t cost too much money”. That would be PBR.

    Of course, someone has to decide whether these principles have been met when the teams deliver their cars for the Jerez test. Let’s say Stefano Domenicali is cosy with the judge, Bernie Ecclestone – I guess that’s just too bad for the other competitors. After all, it’s not like these woefully underspecified regulations actually tell the designer what he’s allowed to do independently of Bernie’s whim in deciding what constitutes excessive driver aid in a given element of the car design, et cetera. There is a vast design space consistent with various sensible humans’ possible interpretations of leaky value-judgements like “not dangerous”, “not too much aid” and so on.

    So as Foseti says, “PBR” is just the transformation of laws into whims. The F1 example renders this intuitively comprehensible – Kling is exploiting the fact that people have a hard time imagining and contrasting the state of reality in which “businesses break the spirit of bright-line regulations” vs. “businesses attempt to comply with principles-based regulation” in the abstract.

    Kling’s idea is an example of legal realism, which is desirable to leftist-idealists because it’s a step away from
    pronomianism towards decision-making by consensus and emancipation from abstract rule-following – which is the
    neurological inclination of leftists.

    As with any regulatory approach, principles-based regulation must be well executed in order to work. A key element is that the principles should have clear meaning. They cannot be vague, as in the United Kingdom, where one finds principles like “A firm must observe proper standards of market conduct” or “A firm must conduct its business with integrity.” To me, those are not principles. They are just glittering generalities that offer no concrete guidance to a firm. […]

    [F]or PBR to work, the principles have to clarify rather than obfuscate. Legislative commentary should include specific examples of conduct that falls outside of the principles, in order to provide further guidance.

    One way to test the strength of a principle is to ask, “Could we audit to test compliance with this principle?” I do not see how you can audit against “must observe proper standards of market conduct” or “conduct its business with integrity.” The terms need to be better defined.

    Kling isn’t stupid. Therefore, he pulls this very neat stunt. The fallacy is in the idea that the type of principle he proposes, “[N]o business should sell a consumer a product knowing that the consumer has no chance of benefiting from that product”, doesn’t also fall foul of this problem. Of course, one could continue to make such a principle incrementally more specific, until one eventually ends up with…a bright-line regulation. But Kling’s pointing to even leakier value-generalisations doesn’t render the leaky principles that he has in mind fit for purpose.

    The principle here is that any financial institution that enjoys a government guarantee has a responsibility to behave prudently.

    Here we have an example of the use of framing – the more logical question to start with in this instance is, “How can a financial institution be encouraged to behave prudently?” but that might lead to heretical thoughts. The best way to encourage prudence in this context is, of course, economic discipline, and the way to allow economic discipline to do its work is to take away the freakin’ government guarantee.

    Also once again, expecting a civilisation to be amenable to the moral laws of the tribe – “Bad corporation – stop that right now!” – is a huge mistake that needs to be exposed wherever it appears.

    Principles-based regulation is not a cure-all. There are many regulatory problems that are better addressed with bright-line regulation. For example, the algorithm for calculating the Annual Percentage Rate of interest should be standardized and clearly specified by regulators. And any regulatory system will have gaps and flaws. After all, those who design and implement regulations are as human as the people who run the businesses that they regulate. But in an increasingly complex and fast-paced market environment, there are likely to be many regulatory issues where principles-based regulation will prove to be more robust.

    Read: principles-based regulation is a nonsensical idea, but if that is the general response of my audience to this piece then I can defend myself by pointing out that according to this tacked-on note, my claims are only “modest and tentative”.

    The phrase “increasingly complex and fast-paced” is intended to arouse a note of consternation in the reader: better stop trying to predict the behaviour of the phenomenon in question, better leave this stuff to the experts. This is the same kind of function that the word “vibrancy” fulfils in the context of ethnic diversity – it is rarely meaningful or apposite to the discussion, but it creates a desired impression in the reader’s mind that discourages or distracts him from thinking realistically about some controversial subject. This is known as priming.

  4. […] are suggesting that rules should be made-up by bureaucrats. Leaving aside that (as I think Foseti would agree) that’s more or less what already happens, it should be understood that this […]

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