Welcome to Stockholm! We Are Learning To Love Our Regulatory State

by Dechert LLP

As an industry, we remain in high dudgeon over the inanity of much of Dodd-Frank, the ideological and often unhinged regulatory instincts of our various governments and the vast amount of effort, time and money it takes to comply with the mind-numbing complexity of rules and regulations that seem to be largely untethered from the goal of solving actual problems. We winge. We boviate. We testify, write white papers, fund PACs and pursue “engagements” with the regulatory apparatchiki in the pursuit of sensible relief. But do we still really care?

Are we witnessing a process of reconciliation? Could it be that the capital markets have found a way to thrive inside the current regulatory state’s bear hug?

That suspicion rang a bell from my undergraduate economics classes and I went searching for what I remembered as the Doonesbury Rule. Since the economist in question was actually James Duesenberry, chasing the Doonesbury Rule was not really productive, but I did get to see a bunch of vintage Doonesbury cartoons (I had forgotten how truly funny Spiro Agnew really was). Professor Duesenberry, has been apparently long forgotten, but my search came up with something called the Consumption Function Theory, which is worth our consideration.

Stick with me here. The Consumption Function Theory relates savings and consumption behavior to account income levels. To hash it up a bit and without reference to any of the mathematics, the underlying notion is that as income decreases, consumption remains stable at pre-existing levels. As income moves down, savings gets suppressed. Applying that to a business context, and as the good Professor might have said: as operating costs go up (so that net income is suppressed), output remains higher than the level of current period net income would justify. Putting it another way, the industry is now bigger than its current profit profile would suggest.

I promised that if you stuck with me, I would get there and here’s the punchline! After the dissidence of absorbing the hits of new, more complicated and more expensive-to-comply-with regulations and more liability, which we all predicted would suppress capital formation, it doesn’t seem to have done that to the extent anticipated. We are just living with it.

Maybe this is a long way around the barn, but look at risk retention for a moment. Risk retention appeared to be a disaster (okay, maybe it still will be). Sponsors wouldn’t be able to hold risk retention and no fund vehicles out there would be able to meet the liquidity and tenor obligations of a third party purchaser, at least on the scale needed to run the biz. What’s happened? There’s enough money, the market is working. And what’s more, folks are getting invested in the current structure. Investment grade buyers sort of like risk retention (even though I’m pretty sure that none of them would pay for it, given a choice) and a number of fund sponsors have raised oodles of money to buy risk retention securities (and that doesn’t even mention the number of hours your trusty attorneys have spent becoming experts in this new branch of arcana). While leaping to Y2K may be a tad premature, the industry has accommodated itself to this new set of rules and found a way to succeed.

Enormous new burdens have been put on the banking system; more compliance, more data capture and reporting, more capital required per units of output and, of course, more liabilities. Do the global banks really hate it? Really? They have built compliance departments that have the resources to actually meet the new regulatory burdens giving them a competitive advantage over smaller banks which have neither the resources nor all the competencies to meet these burdens. They have raised truly impressive amounts of new capital. So, while compliance costs have gone up, and while some regulated institutions have had to exit certain businesses, the business of lending continues to thrive. We’re banging right along!

But wait, if our dear Professor is right, as the regulatory burden increases, something has got to give, right? If your operating costs go up and you keep partying like it’s 1999, profits have to go down. It is a zero sum game.

So wassup? Maybe he’s just wrong. Let’s face it – that is not an uncommon state of affairs for economists. But in this case, I don’t think so. What’s going on is that the pain of all this intellectually untethered macroprudential regulation is being masked by the monetary goodies having been larded into the monetary system by the FOMC and the other central banks around the globe. The opiate of liquidity is masking the pain. When the Great Reversal of liquidity begins in earnest, when the tide begins to go out, we are likely to discover that the enhanced burden of regulation will be way more painful than it appears right now. We will find out that the cost of all this regulation is a real diminution in economic activity as the business’ net profitability no longer supports its current scale. When it happens, it will take us all by surprise, it will be painful, and once again stick us with a long and slow recovery.

So, this is not an apologia for equanimity in the face of regulatory overreach. The regulatory output spawned by the Great Recession has had real and painful negative externalities currently veiled by a sea of liquidity.

There is much that should be done to roll back Dodd-Frank, the Basel rules and the rest of the excesses of the regulatory state. There is much that can be done to rationalize existing rules and acknowledge and fix problems which have in some cases overwhelmed the positive benefit of prudential rulemaking that could do the country and our economy a world of good. The industry should struggle to continue to make it a better and more efficient engine of capital formation for the broader economy. If we don’t get some of this fixed, when the liquidity tide goes out, a very real price will be paid for our political classes’ embrace of this politically popular but largely intellectually flawed regulatory regime.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dechert LLP | Attorney Advertising

Written by:

Dechert LLP

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.