Striking Regulatory Irons While Hot - Essay Example

Striking Regulatory Irons While Hot affiliation Striking Regulatory Irons While Hot “Craftsmen who want to strike ironsinto shapes that suit them know that the iron must be hot and their hammers must be ready” (Shefrin & Statman, 2009). Interest groups in the financial market are like craftsmen who are ready to hammer an hot iron into their preferred shape. The cause of heat in regulation irons are changes in financial markets such as change in economy, plunges from boom to frightening crashes, change in technology, and political changes. For example, bankers are ready with their hammers to hit the hot iron, so they can allow high interest rates on credit card. On the other hand, consumers are also ready to hit the hot iron to place low caps on the interest rates (Shefrin & Statman, 2009). This analogue reflects facts that are frequently occurring in the society. Most financial market players highly prioritize their financial positions, thus find ways to utilize financial market condition by implementing rules that could make their position better therefore benefit than others. Stigler categorized this as “capture theory”, where groups like bankers, politicians, lawyers, union members, regulators, and employers have own interests of maximizing their wealth, and often this stimulates conflicts in society (Shefrin & Statman, 2009). This summary shows how groups implement, or adjust regulations, or rules in financial market to benefit them. In 2009, credit card regulations were a hot iron. This happened after financial crisis of 2008, and the US government realized that they needed to protect the society from further loss of money. Thus, it would help the country’s socio-economy growth. The US government established the Responsibility and Disclosure Act of 2009 (CARD). This act benefited cardholders over credit card companies, and showed dynamic of capture theory and fairness. While advocates of lax regulation emphasized on right to freedom from coercion, advocates of restrictive regulation argued that Credit Card companies often create regulations, or contracts that are very difficult for potential cardholders to understand the terms. This often negatively influences the cardholders because they do not fully understand the contracts, and in future, they may end up to have limitation in accessing their credit card information, and paying high interests rates, or penalties. The 2009 Act required Credit Card companies to clearly state their contracts, and it restricted individuals under 21 years old because they have less knowledge of understand legal terms. The shape of regulatory iron that favored credit card companies’ decades before was struck in favor of cardholders in 2009 (Shefrin & Statman, 2009). In contrast, in 1970, when there was rapid inflation, economic activities declined and credit shrunk, and these circumstances negatively affected the banks, and lenders. At this time, the Supreme Court decision favored credit card companies. Marquette decided that lenders could charge high interest rates to its customers based on where the bank reside. Additionally, usury law that is implemented in South Dakota set very high interest caps in their state. For example, Citibank relocated their banks to South Dakota to fix their financial condition. In this state, Citibank could raise their interest rate, and payment penalties (Shefrin & Statman, 2009). Having more income made them growth, and could open more jobs for society. Finally, most of half Americans paid high interest rate. This shows another dynamic of capture theory and fairness that favored banks and lenders in 1970. The Fair Credit Reporting of 2004 somehow gave another good outcome to lending institutions. This act limited state regulation on the business of credit card companies and prevented states from imposing usury law and fees limits. This seems good to borrowers, but practically is not. The outcome of this “Fair” act is not fair because for example, consumers from California cannot ask their state to protect them from lenders in South Dakota, and Delaware (Shefrin & Statman, 2009). This act was established through the effort of Controller of the Currency (OCC), which lobbied the governments to implement this act to give advantage for banks, and lenders. If banks showed good performance, it would be a sign of good work by OCC, which is the regulatory body, because they can facilitate a good economic situation in the US. This shows the capture theory about the bank regulation because they have “connection” with the government, which can implement acts, or rules that favor their position. In addition to credit card regulation, there is capture theory conveyed in the insider trading regulation as stated by Haddock, and Macey in their capture theory based model in 1987. Their model showed the interest of two groups, which are corporate executives, and Wall Street professionals (investment bankers) (Shefrin & Statman, 2009). The public and shareholders interest were left out and only interest of executives and investors mattered in regulation determination. The investment bankers do not want the insider trading because it is not fair for them and for shareholders. With insider trading, corporate executives can gain a lot of information, which will maximize their wealth because they use the inside information being the first in line to receive advantage of investing in stock trades. With this condition, they do not disclose all information to society. Thus, investment professionals fought until the birth of Securities Exchange Act, which required all companies to disclose all of their financial investments and decisions to society (Shefrin & Statman, 2009). This fairness feels most for public, but not to the industry and its executives. As a result, SEC received a lot of negative comments from industry, and positive comments from the public. There is also capture theory in The Riegle-Neal Interstate Banking and Branching Efficiency Act 1997, which allowed banks to expand their branches to other states and buy other banks across country. This Act obviously favored the big banks, but not the weak ones because weak banks had less capital, and networks to expand their businesses. Previous restrictions on Branching were supported by small banks because they limited competition (Shefrin & Statman, 2009). This new Act allowed banks to build automated teller machines and have money market funds in other states, and reduced the effectiveness of restrictions on branching and inter-state banking. At this point, government established rules for efficiency, and not for fairness because the big banks are “too big to fail”, thus governments want to pick the “winner” to support the US’ economy. Critics regarded it as an overly friendly Act that why big banks support it (Shefrin & Statman, 2009). Nevertheless, the Craftsmen really need to hammer the iron once it is already hot and not lukewarm in order to shape rules or regulations that have impact in the society. The aftermath of the 1987crash unlike the one of 2000, was merely lukewarm. It was a battle of two interests groups of NYSE, and CME, where both of them had information discrepancies on futures prices. So investors tended to buy profitable future from the CME, and sell stocks on the NYSE. Specialist in this trade suffered losses to an extent of bankruptcy of some (Shefrin & Statman, 2009). Another example is the interests between Merril Lynch, and Salomon Smith Barney, one an investment banker, and the other one a researcher after the 2000 crash. The conflict involved pressure on researchers to give flattering appraisals of firms so that investment bankers would snag their business. Both appraised companies not based on principle of fair dealing. Thus, it created a chaotic condition in the market because there was no clear reference point of investors making the market unstable. There was also no one who took an initiative to hammer the hot iron to shape something that could positively influence the situation, until the global settlement came in to control the crash (Shefrin & Statman, 2009). This shows that keeping the iron too hot for long is not good because it does not produce a fair or efficient outcome. Many regulatory institutions have been set since the 1929 crash but the performance of many has been questioned. Personal interest are what guides regulatory body actions since it is a matter of who hits the iron when hot. Hot Irons, or society condition are shaped by regulations over time. It shows that we make our own ranking to judge the fairness, and it depends on our own perspective. We highly value fairness, rights of equal processing power, and freedom of impulse. This means that we are paternalistic, and are not libertarian. In our vision, it is good to have lower interest rate on credit card, and having bargaining power in market. Nevertheless, libertarian highly value freedom from coercion. For example, using public money to default big bank that has high leverage in the markets (Shefrin & Statman, 2009). The dynamic of hot iron is changing over time sometime it slows, and swift. The changes always affect the financial markets, economy, politics, and society. “Do not waste a crisis” (Shefrin & Statmant, 2009). This statement explicitly explains the dynamic of hot iron. Do not waste the opportunity, and keep the hot iron too long until it becomes lukewarm. Regulation is needed to shape the structure of society before the heat evaporates, and its potential gone. Often in reality, politicians hit it too hard, or too soft, which end up with mistakes. This happens because of the uncertainty of future market. Changes in regulation can improve efficiency and fairness, but also cannot do at all. References Shefrin, H., & Statman, M. (2009). Striking Regulatory Irons While Hot. Journal of Investment Management, 7 (4), 1-14. Read More