Thursday, October 8, 2009

Regulation versus Wealth

By Douglas Kohn

For all the talk of implementing new regulations to tame finance, there are still elements of necessary deregulation that are being overlooked by the Federal Government.

The rules used to say that no one could get a mortgage unless they were able to pay 20% down on their home. This made sense, as the social consequences of having to later kick someone out of their home are more damaging than having large numbers of people not own their own home in the first place. This would still be considered “light touch” regulation.

America simply should restore the old regulation regime but consider deregulating in other areas. One of the most overlooked problems in America today is what the CPA Journal called “The Chilling Effect of Sarbanes-Oxley.” Sarbanes Oxley was passed (as usual, in a panic, with nobody reading all of the bill) in 2002 in response to the unusually large series of corporate scandals that came to light in the previous downturn. Included in these were Enron, Worldcom, Tyco and Arthur Andersen.

Arthur Andersen’s main role in that crisis was to be Enron’s auditor. This means they were an independent body hired by Enron to make sure the company’s books were clear of errors and to discover any possible fraud. As they did not do this correctly through both negligence and corruption, there was a crisis of confidence in the system. In response Sarbanes Oxley was passed to tighten auditing rules. An example of a new regulation was that CEOs had to sign off on the company’s financial statements and on the findings of their independent auditors.

The aforementioned regulation is not one of the more damaging ones, but the climate created by Sarbanes Oxley has made it grossly expensive for medium sized firms to go public on the stock market. The average cost of an Initial Public Offering (IPO) has reached $750,000. The result of this is that many American companies now find it easier (and cheaper) to bring their public offerings overseas, notably on the London Stock Exchange but to others as well.

Reform of Sarbanes Oxley is urgently needed to keep America’s medium sized firms competitive and able to raise money on the stock exchange for growth.


Anonymous said...

In almost all instances after emergencies of any kind, government, in its zeal to be seen doing something, passes bad legislation, e.g. Patriot Act. What's funniest about the current atmosphere of regulation is that government created many of the problems we have now through regulation and now it thinks the fix is more regulation. It's like burning one's self on a stove and thinking the way to make your hand feel better is to turn up the heat.

Phil said...

Not sure I necessarily agree with you about creating money down requirements for mortgages. I still believe that if government would keep their hands off it the free-market would set an equilibrium money down price (or requirement as some would say).

With that said I am thrilled to see somebody point to the unnecessary and ineffective regulations of Sarbanes-Oxley. IPOs are a vital part of the US economy and as you said all Sarbanes has done is send them overseas.

DSKohn said...

I don't think the market can provide the necessary standards for getting the large amount of credit needed for a mortgage. If you look at China's stimulus, they are trying to push up consumption (though without raising the Yuan) and at the same time they raised the amount needed to put down on a second home to 40% and put tight limits on margin buying. This was done with the explicit purpose of avoiding a major asset bubble in the wake of abnormally high economic growth from their stimulus package (which the adjustment of credit standards was part of).

That being said there are more and more voices warning of the possibility of an asset bubble in China anyway, in spite of tight controls on where the growth is allowed to go.

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