Regulation: A View from Inside the Machine

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Remarks at Protecting the Public While Fostering Innovation and Entrepreneurship: First Principles for Optimal RegulationUniversity of Missouri School of Law Feb. 8, 2019
Thank you, Thom [Lambert], for that kind introduction. I am delighted to be part of this conference, but am sorry that I cannot be there in person. I had high expectations when I picked up Thom’s book on regulation shortly after it first came out several years ago. [1] Those expectations were exceeded by the clear and compelling way in which the book wrestles with the difficulties faced by regulators as they seek to design regulations that solve problems without creating larger problems in the process. As the book explains, “regulation . . . always involves trade-offs. The $64,000 question is how policymakers should proceed to ensure that they strike those trade-offs in a manner that creates as much social welfare as possible.” [2] I appreciate the book even more now that I am sitting in a regulator’s seat. Incidentally, as a regulator, I must give the standard disclaimer that the views I express today are my own and do not necessarily represent those of the Securities and Exchange Commission or my fellow Commissioners.
Entrepreneurship and innovation do not have the happiest of relationships with regulation. Regulators get used to dealing with the existing players in an industry, and those players tend to have teams of people dedicated to dealing with regulators. Entrepreneurs trying to start something new are often much more focused on that new thing than on how it fits into a regulator’s dog-eared rulebook. Regulators, for their part, tend to be skeptical of change because its consequences are difficult to foresee and figuring out how it fits into existing regulatory frameworks is difficult.
Society, however, often pushes regulators to accept change. After all, society benefits from entrepreneurs’ imaginative approaches to solving problems and willingness to go out on a limb with a new idea. Society welcomes innovations that make our lives easier, more enjoyable, and more productive. In many sectors, therefore, entrepreneurship and innovation evoke overwhelmingly positive responses.
In the financial industry, entrepreneurship and innovation do not always face such a warm reception. Financial innovations, for example, were fingered by some as the cause of the last financial crisis. Former Federal Reserve Chairman, Paul Volcker, in a negative post-crisis appraisal of financial innovation, concluded that: The most important financial innovation that I have seen the past 20 years is the automatic teller machine . . . . How many other innovations can you tell me of that have been as important to the individual as the automatic teller machine, which is more of a mechanical innovation than a financial one? I have found very little evidence that vast amounts of innovation in financial markets in recent years has had a visible effect on the productivity of the economy . . . . [3]
Some people might disagree with Chairman Volcker. Take for example the man who got stuck inside an ATM a couple years ago. [4] In the course of repairing the machine, he got locked inside it. Without a cellphone or any other obvious way to contact the outside world, he was stuck. It is good that he thought to slip written pleas for help to undoubtedly baffled customers. Instead of a receipt, customers got a note reading “Please help. I’m stuck in here and I don’t have my phone. Please call my boss at . . . ” [5] A customer heeded the call, and the police rescued the repairman.
The moral of the story is that every innovation—even one that almost everyone agrees is good—carries with it some risk. Some people may get hurt by the innovation in ways we would never have imagined. Others may be helped by the innovation in ways we would never have imagined. Some people will use the innovation in ways we wish they would not. We would be better off without some innovations, but we might not know that until after enough time has passed to see the harm they cause. In other instances, the true value of an innovation may not come to light for years.
Technological progress in the financial industry offers the same mix of hope, promise, and risk that technological progress in other parts of our society offers. As regulators, therefore, we must allow innovation to proceed, even as we put in reasonable safeguards and watch for unanticipated consequences.
The SEC’s attitude toward innovation is important because we regulate an industry that is a key gatekeeper for progress and productivity in the rest of the economy. The United States has benefited greatly from the relative importance of non-bank financing. Without the funds that the capital markets provide, companies in other sectors of the economy would not be able to explore new ideas and develop new products and processes. As a regulator, when I think about protecting the public, I think not only of protecting investors, but also of e...