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On 'Complexity Risk'

3:19 PM, Jan 19, 2012 • By DANIEL HALPER
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Joe Nocera, writing in the New York Times

money.USCurrency Federal Reserve

"What has caught me up short recently is the emergence of a new critic of the banking regulations that have been pouring forth from Washington and Europe. Her name is Karen Petrou, and she is the managing partner of Federal Financial Analytics, a consulting firm that, among other things, analyzes bank regulations for clients.

"Unlike many in the banking industry, Petrou is not ideologically opposed to regulation. For instance, she was a critic of the lack of regulation that allowed so many sleazy subprime mortgage originators to emerge from the precrisis ooze. Yet, now, she’s worried about something different: that the hundreds of new mandates required by the Dodd-Frank law are creating a new kind of risk. She calls it 'complexity risk.' As she put it in a speech she delivered last week in New York: 'If we don’t understand the cross-cutting effects and inherent contradictions in all of the stringent standards now being written into final form, we risk doing real damage to the sound, stable and — yes — profitable financial industry regulators say they support and the economies sorely need.' . . .

"Why does complexity risk matter? One reason is that the more complex the rules are, the greater the likelihood that smart bankers will find ways to game them. Another is that contradictory regulations, however well meaning, simply don’t make the system safer. But the most important reason is that complexity risk is having an effect on business — and that’s not helping the still-fragile economy.

"Petrou says that in her own practice she has seen deals fall through — especially in the mortgage industry — because nobody can figure out how the new rules will be applied. Given how badly the country needs a revived housing industry, this is nothing short of tragic."

Whole thing here.

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