Regulatory Reform: The System, Not The Software

Trading stood still on more than 200 companies Monday, as a server kept the New York Stock Exchange from publishing quotes for most of the day. Taken alone, this seems like a technical glitch.

But combined with earlier problems, such as Knight Capital in August, Facebook in May, BATS in March and other issues this year, the glitch begins to look like a SNAFU. And U.S. regulators are taking note.

Second Winded

The reelection of U.S. President Barack Obama and his enthusiastic crop of second-term appointees certainly injects new blood into the stream of veteran officials who are battered from four years of partisan roadblocks, not to mention disheartened by having to fix messes from 2008 and before. And rule making moves slowly, as mentioned Monday.

Though the pace of regulation writing for the Dodd-Frank Wall Street Reform and Consumer Protection Act will likely pick up in the post-election season, political and organizational flaws at the heart of the financial system will make true reform difficult, if not impossible, according to ProPublica’s Jesse Eisinger. Problems include:

• The Security and Exchange Commission’s inability to fix a loophole that allows money market funds to disguise risk
• The U.S. Senate’s failure to consolidate enforcement oversight
• Meager resources allocated to certain agencies.

“These agencies are still run by commissions, not single heads, and they rely on Congress for their financing,” Eisinger wrote in The New York Times Dealbook on Wednesday. “It’s little surprise that such a structure creates plodding impotence.”

Better Off Fed

Yet these regulatory institutions and Congress are crucial to a smoothly running economy. Everything about the financial crisis tells us that exchanges and financial firms cannot regulate themselves.

And central banks cannot fix the economy on their own, as Mohamed El-Erian pointed out in The Financial Times on Thursday. Aside from setting interest rates, quantitative easing, meddling in U.S. Treasuries and more, the Board of Governors of the Federal Reserve System has had to pick up the slack for the previously mentioned ineffectual politicians and authorities.

“The Fed feel that they have no choice but to do more using imperfect, untested, partial and, potentially, risky tools,” El-Erian said. “At best, Fed officials have provided more time for the system to heal, but at the risk of growing collateral damage and unintended adverse consequences.”

Watch Your Head, Chicken Little

For perspective, NYSE was able to explain its Monday trading halt: It was the byproduct of consolidating its U.S. and European markets onto a universal platform. It wasn’t the end of the world because other exchanges were available for trading during the downtime.

So the electronic trading sky isn’t falling. Many of these incidents are likely the symptomatic of an industry in flux -- thanks in no small part to a huge data influx.

But there are cracks in the sky elsewhere. Policymakers’ absence may dictate that the Fed continue employing its experimental strategies as early as the New Year, El-Erian noted.

“Expect the Fed to move to quantitative thresholds, announce additional outright purchases of securities, and reintroduce Treasuries to their list of targeted instruments,” El-Erian said. “But unless (and until) politicians and other policy making entities step up to their responsibilities, this unusual policy activism will fail to deliver the economic outcomes that the country needs and deserves.”

Related Articles:

“New NYSE glitch puts pressure on SEC to act” by Bruce Love

“For Obama, No Easy Fix for Convoluted Regulatory System” by Jesse Eisinger

“Expect more from the Fed -- and soon” by Mohamed El-Erian