Rewarding Regulators Like the Regulated

What do you get when you cross a brief, vegetative vacation with an extremely fast-start to the new year? For me, those circumstances recently combined to create a very bad case of “writer’s block.” Nor was it a single-issue case of writer’s block like Andrew Sullivan experienced after his respite. Mine was a pervasive block; it was the Hoover Dam of writer’s blocks.

Thankfully, that block shattered this morning after I read Stephen Chapman’s column, “The empty case for even more regulation,” wherein he counters the Madoff-inspired rush to write volumes of new rules. [H/t RCP.]

Note to my more left-leaning readers: Before you fire off an angry comment about how misguided you think Chapman is, take a deep breath. Yes, Chapman is more right-leaning than you, but he’s not calling for an end to regulation or blaming regulation for the Madoff mess. In fact, I take his column to argue nothing more radical than this: There were already sufficient rules on the books to prevent Madoff from robbing people blind. The mistakes made were not the result of a lack of rules but of human imperfection. In other words, the regulations were just peachy; the regulators were not.

Chapman then offers the line that ended my writer’s block:

… con artists will often outfox regulators, if only because they have far more to gain from carrying off a fraud than civil servants have to gain from stopping it.

Granted, that’s not a new argument, but I increasingly think it’s a very powerful argument, especially if we attach its logical addendum, namely: Start rewarding civil servants (in this case, financial regulators) like the parties they regulate. Consider:

Madoff allegedly purloined $50 billion worth of investments.

If the reward for stopping said thievery had been a 1 percent commission — paid by the defrauded investors to the regulators who ended the scam — the regulators would have earned up to $500 million.

Sure, some of that amount should rightly go to cover the imbedded costs of the regulatory body, but a fair portion of it (let’s say 30% or $150 million) could be paid in “crime-busting bonuses” to the individual regulators.

If those individual regulators were a team of 10 they could have earned average bonuses of up to $15 million each.

That might sound like a ridiculous sum, but it would clearly start to put the potential incentives for the regulators on par with the incentives often earned by the regulated. Of course, you might argue that the defrauded investors would protest paying even a 1 percent commission. True — but don’t you also believe they’d prefer to learn that they’re getting $49.5 billion returned to them, rather than something substantially less … like $0?

Then again, with that level of incentive, some regulators might be compelled to commit fraud of their own variety; pushing convictions on the innocent just to claim their bonuses. And that, in turn, could lead to another level of bureaucracy, the regulators of the regulators, creating an entirely new layer of opportunity for human error and/or ill intent.

Perhaps there’s a balance to be struck here, some middle ground between our desire for perfect rules and perfect actors in an imperfect world.