Elizabeth Warren’s principles

By Felix Salmon
September 30, 2010
Elizabeth Warren isn't shy about taking sides in the debate between rules-based and principles-based regulation:

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Elizabeth Warren isn’t shy about taking sides in the debate between rules-based and principles-based regulation:

In her speech and in an interview earlier in the day, Warren said she hopes to take a more “principles-based approach” to regulation, rather than simply saddling companies with more of what she calls “thou shalt not” rules — which make for burdensome, costly compliance and which banks often start trying to skirt as soon as they are written

“Regulators can make more pronouncements from on high, identifying suspicious practices in the various markets and banning them. Or regulators can layer on more disclosure requirements,” Warren said in her remarks. “But neither restores customer trust.”

Rather, she said, “Let’s measure our success with simple questions” — Can customers understand a product? Do they know the risks? Can they easily figure out what it really costs?

Warren, remember, is a law professor: she knows full well that the main effect of laying down rules is to send a thousand lawyers scurrying to find ways around them. And she’s surely also seen the way in which other regulators — the SEC springs to mind — become overrun by lawyers looking for people breaking rules, rather than regulators trying to ensure a clean and level playing field.

At the same time, principles-based regulation is new to the US, and will be worrying to banks who will never know for sure whether what they’re doing is allowed or not.


It’s true that a malicious and vengeance-minded principles-based regulator would be capable of wreaking havoc on the banking industry, but the same can be said of a malicious and vengeance-minded rules-based regulator, too.

The fact is that it makes perfect sense for a consumer-protection bureau to regulate from the point of view of the consumer, rather than from the point of view of bank managers. Warren’s simple questions are good ones, and they’re hard to capture with rules. If banks provide valuable products to consumers, then consumers will value them. If, on the other hand, banks create products which are designed to prey on human foibles, then consumers will come to believe, in Warren’s words, that “dealing with banks is like handling snakes – do it long enough and you’ll get bit.”

Ultimately, the Consumer Financial Protection Bureau could prove an important case study for other U.S. regulators thinking about moving to a principles-based approach. Such an approach is hardly sufficient to fend of a crisis, as the UK’s Financial Services Agency can attest. But it probably stands a better chance of doing so than thousands of pages of new rules.


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I think this is a little bit too rosy on principles-based approaches, Felix. I’m not saying it isn’t superior to rules based approaches – it probably is, at least under Prof. Warren – but I think we need to acknowledge the drawbacks, of which I think there are two big ones:

(1) I love Elizabeth Warren as a principles-based regulator. But eventually she’s going to be replaced by a partisan Republican. Its much easier to interpret your principles laxly than it is to repeal rules, both politically and administratively.

(2) Banks don’t get nearly as good notice of what they should be doing under a principles-based approach. I’m not shedding any tears for banks that don’t realize they shouldn’t be fooling with the order of payment to create as many overdraft fees as possible.

What I’m worried about is regulators with goofy thoughts about what is bad for consumers, or who can be lobbied by competing banks into holding goofy thoughts about what is bad for consumers, being able to tar banks who did nothing wrong and didn’t know someone thought they were doing something wrong. I’m thinking of the SEC’s conclusions that short-sellers were moral monsters and needed to be stopped here.

Yes, silly rules can be written – but at least you’ll know about them in advance.

Posted by AnonymousChef | Report as abusive

Felix, be careful what you wish for.

As AnonymousChef notes, principles-based regulation is subject to even wider subjective interpretation, haphazard implementation and inherent abuse than rules-based regulation.

If you support principles-based regulations, you need to ask yourself Juvenal’s question: Qui custodiet ipsos custodes? (Who watches the Watchmen themselves?)

The answer: no one regulates the regulators themselves.

Regulatory agencies have no ongoing real oversight for sins of omission or for sins of commission. And they are government employees, effectively getting sinecures for life. Consequently, it is hard to get anyone fired or replaced for either type of sin.

Regulatory agencies fear only two groups–the various Offices of the Inspector General (OIG) and the infrequent but public Congressional Hearing.

The OIG typically performs only technical or statutory audits (e.g. check the OIG site at ustreas.gov, for example). And the Congressional hearings usually happen way too long after the fact to be effective during the economic cycle.

For example from 2002-2007, bank regulators lacked all conviction for credit issues but displayed a deep passionate intensity to prosecute Patriot Act and BSA/AML technicalities. Even with rules-based regulation, bank examiners spent more time on reviewing the timing of SAR filings than enforcing a prudent ratio of construction loans to capital.

But under a principles-based regulation regime, there might have been no asset quality tests at all from 2002-2007 because there were near zero default rates. Everything seemed so peachy, why bother?

So principles-based regulation works better only when you have a governance mechanism that calls regulators to the carpet for: (i)not doing their job, or alternatively (ii) overdoing their job. And it works better only when there is a mechanism that enforces counter-cyclical regulatory behavior.

In the absence of such governance mechanisms, I’ll take the admittedly flawed rules-based approach.

Viewed through this prism of the lack of regulatory Watchmen, the fact that Congress, through Dodd-Frank, passed the buck to unwatched principles-based regulatory agencies bodes ill for any real, stable, lasting improvement in the oversight of the U.S. financial system by US regulators.

Posted by AABender1 | Report as abusive

In the US, the CFTC is principles-based regulator. At the end of the day though, the CFTC does a lot of rulemaking with a lot of lawyerly type stuff. My impression is some of this can be attributed to the fact there is some market overlap with the SEC, which makes me wonder how principles-based the CFPB can stay when there are a lot of rules-based regulators its going to have to co-ordinate with.
And AnonymousChef’s point stands how principles can be easily subverted depending on who is overseeing the principles. Makes me kinda wistful for the vanilla (or more radically, public) option for consumer financial products.

Posted by br_add | Report as abusive

It’s all about integrity. If business had any, the free markets would work and regulators would not be needed.

If serving customers and helping both your own business and your customer meant anything, there would be no need for regulators.

I love Warren’s approach. But unless some really big people forcefully get behind her, she will be buried by the lobbyists who bribe legislators.

I want Obama to loudly support her every effort. I want to see some effort to instill integrity in government and industry, and even the military. [I know, not possible]


Posted by MarkWolfinger | Report as abusive

If there’s nothing to watch, we don’t have to worry about the watchers’ watchers.

Did we ever figure out who engaged Warren to write a brief for the Supreme Court on behalf of the creditors of NextWave?

Posted by Uncle_Billy | Report as abusive

What are the principles involved in receiving $90m as an expert witness in a lawsuit against a financial services company and then taking a government position as a regulator of said company? And if we are principles-based, the defense that counsel signed off on it so its okay–a rules-based defense if I ever heard one–doesn’t fly.

Warren appears to have an agenda. The principles-based approach may give her enough slack to enforce that agenda. She reminds me of Lillian Rearden.

Posted by Publius | Report as abusive

That’s a phony scandal, Publius, meant to absorb attacks on her credibility and deflect inquiry into her other earlier activities, like the work she did in the land of NextWave, and probably other things that haven’t surfaced yet. Someone with proper legal database access could probably, easily, piece together a not so squeaky-clean CV.

Posted by Uncle_Billy | Report as abusive

@Uncle BillyInnuendo can come back to bite you in the endo Uncle Billy. I am sure anyone with access to your internet cache of searches could probably piece together a not so squeaky clean history as well. Tell a friend when you have a heart attack looking at it, to be sure that erasing it is the first thing he does.

I hope my assumptions and innuendo don’t hurt your credibility!

@Publius 90m? ermm I think not… 90k is a little less then 90m and she didn’t take a Government position. She was doing the consulting before she was asked to work on the commission.

She worked part time doing what she had been doing all along… but now that she HAS a Government position she has stopped doing all work outside of her new position… nice way to twist it all though!

Posted by hsvkitty | Report as abusive

Oh Kitty, have I got a guy for you. Head on over to the Baseline blog and work your magic on Ted K. I think he lives in Garden City. Don’t take any wooden Lunies.

Posted by Uncle_Billy | Report as abusive

Ted K seems like a standup guy with his own brand of magic… and wish he were from up North of me… sadly he is American. Did you mean because he is so obviously bright?

And it’s loonies… after the Canadian Loon on the one dollar coin.

Posted by hsvkitty | Report as abusive