Capital Markets Do Not Need More Regulation, says Ex-SEC Chief Economist Richard Lindsey

Richard Lindsey, former SEC Chief Economist and director of Market Regulation, says the U.S. financial system will grow stronger from the current crisis " but he hopes the SEC will not push forward more prescriptive regulations as a knee-jerk reaction to the financial turmoil.

"As a regulator, you want to give firms enough freedom to fail, or you don't have growth, innovation or people taking chances. But you need to manage the political aspects of it. This is not a Depression, it's not a replay of 1929. It gets played up [in the media], but ultimately the [financial] system will get stronger," Lindsey told WS&T in an exclusive interview on the sidelines of the Actimize annual Client Forum in New York.

Will the regulatory hammer nevertheless fall down on the financial industry in the next few weeks? It's hard to predict, says the former SEC chief economist, since it's at least in part "a political process."

Just a few hours before we spoke, the SEC announced new restrictions on short-selling, where traders bet on prices falling. Lindsey says he hopes this wasn't a hasty early reaction to the crisis. (On Thursday, UK regulator FSA also issued restrictions on short-selling, which some say was a factor behind Wednesday's rescue takeover of HBOS, the UK's biggest home lender, by Lloyds TSB in a $21.8 billion deal.)

Lindsey suggests there will be some U.S. regulatory action in coming weeks on the insurance front. Speaking the day after the U.S. government's $85 billion bailout of AIG, he says the insurance industry may see the creation of a federal regulator (It is currently only regulated at the state level, though there has been talk for years of an optional federal charter that would give firms the choice to be regulated at a federal level instead.)

But in the capital markets, rather than new regulations, firms will probably see an increase in the number of SEC examinations, Lindsey says. "There'll be more time spent inside firms, explaining what you're going to do."

Ultimately, disclosure and transparency are better regulators than rules, Lindsey adds. "The problem with prescriptive regulations is that you have to know the answers."

If you tell someone exactly how to tie their shoe laces, the chances are that when they try to exactly follow your instructions, they won't be able to do it, says Lindsey.

"The problem with prescriptive regulations is that sometimes you get outcomes you don't want. Also, if you draw some lines, the game becomes how close people can get to the line. Flexibility works better."

Still, the current crisis does highlight a lack of accountability, Lindsey contends. Board members of financial firms must start taking more action and more responsibility. "I expect shareholders to take [legal] action."

Lindsey is certain that the financial system will recover from the current crisis. He draws comparisons with the bursting of the dot-com bubble in 2000. Today, the technology industry is booming. Likewise, the financial industry will become stronger as a result of the current turmoil, he contends.

In the meantime, Lindsey refutes industry talk about the possibility of reinstating the Glass Steagall Act, which was implemented after the Depression and in part separated investment banks from commercial banks. The Act was repealed in 1999.

"It was a very long process to remove the law once it was on the books " it was heavily fought on both sides. Congress decided to repeal it," Lindsey said. "And nothing that happened is a result of the repeal of the Glass Steagall Act. The problem has been the investment banks, not commercial banks."