This is how London School of Economics professor Willem H. Buiter has assessed the role of the Federal Reserve in the subprime crisis: “Cognitive regulatory capture of the Fed by Wall Street resulted in excess sensitivity of the Fed not just to asset prices (the ‘Greenspan-Bernanke put’), but also to the concerns and fears of Wall Street more generally.”
What is cognitive regulatory capture? Buiter says it is a form of regulatory or state capture that is not achieved by special interests buying, blackmailing or bribing their way towards control of the legislature, the executive or some important regulator or agency, such as the Fed, but instead through those in charge of the relevant state entity internalizing, as if by osmosis, the objectives, interests and perception of reality of the vested interest they are meant to regulate and supervise in the public interest.
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Buiter writes in his paper, Central Banks and Financial Crises, that “the Fed listens to Wall Street and believes what it hears; at any rate, the Fed acts as if it believes what Wall Street tells it. Wall Street tells the Fed about its pain, what its pain means for the economy at large and what the Fed ought to do about it... Throughout the 12 months of the crisis, it is difficult to avoid the impression that the Fed is too close to the financial markets and leading financial institutions, and too responsive to their special pleadings, to make the right decisions for the economy as a whole”.
Regulatory capture is all too prevalent in the Indian economy as well, be it in the case of certain telecom firms getting favour in allotment of licences and spectrum, or with certain firms winning bids for infrastructure projects, such as the allegations that Maytas Infra Ltd won all the major projects it bid for in Andhra Pradesh. This form of regulatory capture would involve bribing or buying the regulator. Needless to say, such acts are deplorable.
But so is cognitive regulatory capture, even though it doesn’t involve bribes or blackmailing. Some experts in India’s securities market infrastructure are now saying the National Stock Exchange (NSE) enjoys some form of regulatory capture as far as the exchange business goes.
The argument goes thus: any committee on market infrastructure, reforms or new products such as interest rate futures would normally have a representative of NSE, while no other exchange would be represented. There would be instances where another exchange is represented, but NSE would also have a seat on the committee.
An exchange official asks, “Name one committee which has only a non-NSE exchange representative.”
At a recent conference organized by the National Institute of Securities Markets (NISM), NSE had two panellists, while no other exchange was represented in the two-day event. NISM has been established by market regulator Securities and Exchange Board of India (Sebi).
According to a report by MoneyLIFE magazine in October, when Sebi had an offsite meeting in Goa, NSE’s managing director was among the list of participants, with no mention of any other exchange being represented.
The concern is that NSE’s disproportionate access to the regulator could result in legislation that favours it at the expense of competitors and the market at large.
According to an academician who has been on multiple committees, “From a policymaker’s point of view, who do they invite other than NSE for a stock exchange’s perspective. The Bombay Stock Exchange (BSE) doesn’t even have a CEO and even when it did, their representative had comparatively little to bring to the table. NSE, on the other hand, was ready with data and research, which helped the committee.” In other words, whatever form of regulatory capture that’s happening in the stock exchange space is due to the lack of serious competition.
This column has, in the past, listed out what the Indian markets are missing due to the lack of competition for NSE—product innovation, better use of technology, cost cutting and customer satisfaction. Broker members don’t say it openly, but exchange officials are said to be arrogant because of their monopoly position.
Now, alongside this list, comes the problem of regulatory capture, which makes it imperative for policymakers to salvage the situation and create an environment that encourages competition.
Sebi has made a good start by encouraging it in the currency futures segment, but more needs to be done. The government would do well to relax the shareholding restriction for strategic investors, be it Indian or foreign.
BSE desperately needs a new management and vision, which a global exchange would be able to provide. While Deutsche Borse and Singapore Exchange are investors in BSE, they have but a 5% stake and would need much more to exercise control.
And now that concerns about regulatory capture are being raised by some market participants, the regulator would do well to give representatives from other exchanges as much say in committees and conferences to be seen as unbiased in all respects.
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