Overcorrection is a very human failing. Having confronted a personal crisis stemming from some behavioral characteristic, human beings often shift their current behavior dramatically, at least momentarily. A trivial but instructive example is the driver who slows down well below a posted speed limit just after receiving a ticket for exceeding the posted speed limit. Of course, the overreaction doesnt last indefinitely. Behavior is too well anchored for that. Human behavior reverts to old, well-established modes in very short order. Mean reversion is not only a fundamental characteristic of markets; it is also an enduring aspect of human behavior.

Seen in that light, what should we make of recent efforts by our financial regulators to impose specific risk management profiles on public companies The basis for this enlarged protrusion into private decision-making by various financial regulatory bodies is governments reaction to the pronounced failures of our financial system leading up to and during the financial crisis of 2007-2008. Government was asked to become the captain of the bailout patrol. Boats everywhere seemed to be sinking and the passengers seemed quite likely to go down with the ship.

This massive intervention by government into the financial sector—the largest since the Great Depression—took various governmental entities into unknown waters. The Fed stumped up a $29 Billion dollar loan to J.P. Morgan Chase, to eliminate the coming wreck of Bear Stearns; a financial triumvirate of Fed, Treasury and the FDIC plunged into the rescue business in a very big way. It can be argued that the actual behavior of government entities went far beyond previously agreed limits to government powers that had never been specifically authorized by appropriate legislation and tested over time within our legal system. The rush to fix the calamitous state of our financial system outran our ability to actually analyze what was wrong.

Massive changes in government policy do not go unnoticed. Government interventions into the financial sector, replete with charges of overpaid executives, mismanaged risk and questionable financial ethics triggered vast objections to what seemed to be beneficent government largess. Thus was triggered a massive outcry that the rich were being helped while the poor suffered. A faulty syllogism of Main Street vs. Wall Street became the organizing theme of new financial rules, regulations and edicts. Central to this new found government interest in financial regulation was the implicit substitution of government wisdom for corporate self-governance. In particular, excessive leverage and dubious risk management by managers and a noted failure of boards and other monitors to restrain the zeal of corporate managers, has given birth to massive efforts by financial regulators to substitute their judgment of appropriate risk and leverage levels for the judgment of corporate officials, boards of directors and ultimately equity and bond holders in financial markets. This pronounced trend toward intervention is based on the view that financial markets are inherently unstable and the public is best served by unbiased government regulators intervening in private decision-making because government represents the broader stakeholder and citizen interest of appropriate corporate behavior. Whether financial markets are inherently unstable is an arguable scientific proposition. Yet financial scientists disagree; witness the recent Nobel Prize awards to three rather distinct views on the subject. There are many unintended consequences based on faulty scientific reasoning.

There is more to this growth in government intervention than first meets the eye. Some consequences receive scant notice. There is, for example, a distinct lack of interest in the failures of various corporate boards to maintain some reasonable level of dispassionate review of the actions of management, particularly the risk management practices of senior corporate officials. Of course, there is a fundamental reason why boards (as well as other monitors of corporate behavior) dont stick their noses into the risk management practices of corporate managers. The typical board member, when asked what she was doing while the corporation took on such excessive levels of risk and leverage, would reply that such a review is not within the scope of their duties. They are not there to second-guess the risk management practices of the managers. Moreover, our legal institutions support that theory by placing directors out of reach of shareholder derivative actions on the grounds of the rule of business judgment. The care and duty proscriptions that govern the scope of director actions dont require a director to intervene when questionable risk decisions by managers occur.

Since the behavior of a board of directors is the pivotal element in our corporate governance setup, a distinct lack of interest in risk management by the board conveys a hands off attitude by other monitors such as auditors or outside general counsels. This leaves most of the risk management burden to be handled by managers who are highly compensated by well established performance pay systems. In extreme cases, the fox is overly compensated for watching the chicken coup. As we now know, were there any doubts before, this is not an optimum arrangement for markets to be well informed about the risk characteristics of particular firms. It is hard to be rational if essential information is left out of the data set!

Treating the problems of risk management and leverage by government puts the market out of business. If the trend toward more rules, more restrictions and making government the arbiter of corporate decision-making, makes economic decisions a function of political persuasion. The benefits of competitive firms seeking to improve returns to their owners are diminished, and corporate decision-making becomes more and more an exercise of how to evade or escape the rules. By these government efforts, we are destroying a fundamental element that drives capitalist enterprise. It now appears we have gone a fair distance down the road. We are empowering non-owners with the authority to second-guess the results of managerial decisions. The market may not be perfect and perfectly rational each and every second, but do we believe that government will really do better Wouldn’t it be better to redefine the role of directors with regard to corporate risk management by creating a downside as well as an upside to their behavior Risk management by government can only have two outcomes: suppressing risk-taking or making risk decisions in a voting booth. Current risk management can be improved, but do we really believe that government offers a better mechanism for instituting more careful assessment of the benefits and costs of corporate decision-making This is a very dangerous road on which to travel.