Wall Street Sets the Rules for Regulators

"Herod: I'll tell you what, I'll be a Good Samaritan. What's the cheapest gun you got? Not in a case. I mean the cheapest piece of worthless crap you have in the whole miserable store.

Kid: All right. (Brings out the cheapest gun and slams it on the counter). 5 bucks.

Herod: Sold!

Kid starts to put bullets in the gun.

Herod: What are you doing? Preacher here's got the Lord on his side. He only needs one bullet. Just one. Otherwise he might be tempted to shoot his way out of town." – "The Quick and the Dead."

The current dynamics of the regulatory overhaul is a depressing development. While we're normally quick  to criticize regulators (and for good reason), we also have to admit that monetary deprivation of such agencies by Republicans, as evidenced by budget cuts for the Commodity Futures Trading Commission, transfer some blame to anti-regulatory forces in Congress. Regulators currently entrusted with the task of policing Wall Street are facing a well-funded, well-connected and politically shrewd beast.

In essence, regulators are not writing the rules for Wall Street. Wall Street is writing the rules for regulators.

A few months ago, for instance, the CFTC was given the power to oversee derivatives and futures markets. At the same time, according to Reuters, Congress plans to cut $25 million (a 12% decrease from a year before) from the CFTC's budget in a time when it desperately needs more resources to effectively accomplish its new responsibilities.

It is remarkable, although not surprising, the most restrictive language in the new appropriations bill, which set the CFTC's budget, came from Wall Street lobbyists. What's more amusing is to hear the authors of the bill vie for fair and effective regulation of the swap market, offering suggestions on how that sort of regulation should be achieved and then cutting funding that would undermine the implementation of those very suggestions. This is schizophrenic!

With these large budget cuts, how can regulators like the CFTC effectively monitor the financial markets? The current antiquated computer systems are unable to track technologies such as high-frequency trading, an obscure, but powerful Wall Street niche that commands the brightest minds and the thickest purse. Essentially, the appropriations do not match the needs of the regulators and the regulators are always a few steps behind Wall Street's technology.

Additionally, House Republicans also demand that before the CFTC implement anything they must conduct a comprehensive quantitative analysis of the impact of the rules on swap dealers (as specified by Dodd-Frank), position limits (also specified by Dodd-Frank) and the registration of commodity trading advisers (as specified by the Commodity Exchange Act).

We think it's a brilliant business model for Wall Street. First, it doesn't get any headlines – do you expect an average person to read anything that has "regulatory" and "appropriations bill" in it? Second, you can pass as many as 100 tough Dodd-Frank bills and placate the public, but then quietly work on carving out loopholes or exceptions and, if that isn't enough, just deny the regulators the funds! Wall Street arms itself with heavy, sophisticated weaponry. No amount of money and resources are spared when building a high-frequency-trading desk and no amount of money is spared on lobbyists. With the complicit help of Republicans in Congress, Wall Street deliberately puts itself in the position of handing out weaponry to its watchdog, and, surprise, hands him an old wooden 19^th-century pistol. And then, to add insult to the injury, it also demands the watchdog conduct a thorough analysis (not just an "administrative check") using that old wooden 19^th-century pistol to assess the damage it can have on Wall Street.