Why Is Everyone So Down On The Rule Of Law?

Arnold Kling earns a rare (for him) RWCG Demerit™ for writing in favor of “principles-based regulation”, or as I like to term it, Yglesiocracy. What is ‘principles-based regulation’, or PBR as they superfluously acronymize it? (Note to self, idea for new Sonic’s razor: anything for which its proponents have decided to try to push a superfluous acronym, is probably a bad idea). Kling explains:

With PBR, legislation would lay out broad but well-defined principles that businesses are expected to follow. Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines.

Kling does not go on to explain whether the size of those fines are set according to (gasp) rules, or rather just described via ‘principles’, leaving regulators wide leeway to make up whatever-size fines they want. But you get the idea: in short, Kling is arguing against the rule of law, whose importance he dismisses.

In principle, the advantage of traditional rules-based regulation is that the regulated entity knows exactly what is legal and what is not.

You might naively assume that it’d be a good thing if citizens can know exactly what is legal and what is not as they go about their daily affairs and then kiss their children good-night. But you’d be wrong: some of them should be sometimes randomly fined and/or thrown in jail, according to Kling’s preferred setup, the rule of regulators. Is what you are doing illegal? Ask the commissar, he’ll figure it out, according to ‘principles’, and then inform you. (And, tell you what fine to pay, if there is one.)

He cites three example situations where, he says, “PBR” would be better, and they are all strange. The first is a credit-card company trying to sell $59.95 credit-check service to someone with a $200 limit on the card he has with that company, which is supposedly bad because (per Kling) ‘no business should sell a consumer a product knowing that the consumer has no chance of benefiting from that product’. Leave aside the obvious jokes one could make about how many products this would apply to – really, does any person have ‘a chance of benefiting from’ a Chia Pet? Spam? Soap Opera Digest? Funyuns? etc – not to mention the service deals that places like Best Buy are always trying to hawk when you buy a stereo from them (do they push those things because they think you’ll use them or not-use them, hmm?). Because I don’t even understand the assumption in the first place. Who’s to say that consumer ‘has no chance’ of benefiting from checking their credit record. Just because their limit on that card is $200? But so? Maybe their credit will improve – maybe its being $200 is a result of a mistake and checking their credit record will help – etc. I don’t necessarily think it’s great that a card company would try to push-market this sort of thing, but you can always just say no, and if it really bothered me, I’d cancel the card and switch to some other company. Why does the consumer need ‘protection’ from anything here in the first place?

The second example is Freddie Mac making too-easy loans. Leave aside the fact that GSEs were making easy loans in part due to pressure from the government itself (thus, the idea of this problem requiring a government solution is rather ironic). Kling says this violated a principle he’d set out as, ‘any financial institution that enjoys a government guarantee has a responsibility to behave prudently’. Oh, okay then! Just behave ‘prudently’! I don’t even know what this can possibly mean in practice. Quick, JP Morgan wants to sell $Xmm IG9 10y protection; is that ‘prudent’? Can/should they do it? Says who? How/when shall they know? What about $Ymm? What about buying protection? What are the allowable ‘prudent’ positions in IG9 10y they are allowed to have at any given time? Hopeless. (Later he describes a couple of English-law principles as too ‘vague’ to be of any use. Healer heal thyself.)

The third example, aimed at the MF Global case, says ‘the chief executive of a company has a fiduciary responsibility to make certain that systems are in place to protect customers’ funds’. The thing is, I’m sure that ‘systems were in place to’ protect MF Globals’ customer funds; the problem was not the lack of ‘systems’, it’s that they evidently didn’t work (or were undermined, we still don’t know, I think).

Here and elsewhere Kling seems to confuse the verifiable existence of ‘systems’, ‘checks’, etc. for the actual protection of the thing. How would this work in practice? Either one could say ‘we had systems, they just failed’, and stay clear of Kling’s principle (so what’s the point?), or we have to understand that principle to mean that you can put executives – i.e., people – in jail for events that are, literally and realistically, beyond their control. Oh what’s that you say? It’s not beyond their control? Executives can and should be understood to personally control and be criminally liable for literally all actions and events within some giant x000-person corporation, and this assumption should be written into regulations principles? Yeesh, now who’s guilty of nirvana-fallacy thinking?

There is a sense, a very trivial sense, in which ‘principles-based regulation’ is unobjectionable. Let’s take murder: surely the various laws against murder basically just say You can’t murder, they don’t bother to lay out specifically every possible conceivable way to murder someone, and then ban that act (‘…and you can’t jam a screwdriver into someone’s eye socket until it damages their brain making them dead, and you can’t…’). So you could say, I suppose, that ‘don’t murder’ is the ‘principle’ that is, then, enforced by prosecutors, judges, and juries sussing out in their minds whether you violated that principle. An analogous example suggests itself in business: don’t commit fraud. ‘Fraud’, in the various laws, is probably indeed described in a ‘broad but well-defined way’ that has to be applied to any given case.

Sure, I’d have no problem with ‘principles-based regulation’ if that’s all it means. But that works in part because the ‘principles’ in question are themselves so well-defined that there is broad background societal and historical agreement about what they mean; they rise above ‘principles’ and connote specific acts that are reasonably well-understood by all in advance. When and where that can be done in financial and other regulation, then okay. ‘Fraud’ appears to be one such example. But to try to expand this to vague ‘principles’ like ‘be prudent’ doesn’t work. And there are cases where we want to regulate things that simply don’t lend themselves to being cast in the form of a principle; quick, how would you state the ‘principle’ behind regulator-enforced capital requirements? ‘Have enough capital’?

I would suggest there are some issues you need to either state in the form of a number, or be silent on. For better or worse, our Congress and regulators take it upon themselves to regulate many issues of this type. Trying to phrase such regulations as ‘principles’ only succeeds in making them vague. But vague laws defy the rule of law. Why is everyone so down on the rule of law?