The Cheerios Effect

As the world’s financial markets become increasingly complex, folks charged with regulating these markets face the daunting task of trying to rein in out-of-control trading schemes that have played havoc on consumers (think MF Global), big banks (think JP Morgan), and even on whole economies (think euro zone).

Bart Chilton | Commissioner U.S. Commodity Futures
Bloomberg via Getty Images
Bart Chilton | Commissioner U.S. Commodity Futures

One thing is clear: financial markets are global, they are interconnected, and regulating them—to the extent possible—has to take on a universal theme.

Many years ago, fluid dynamic scientists explained why it is that some floating substances attract one another. They called it "The Cheerios Effect." You may have seen this phenomenon played out if you’ve ever noticed how breakfast cereal tends to cluster together when the milk is added. Researchers say it has to do with surface tension and buoyancy.In the financial world these days, there certainly is tension and if we’re going to have the buoyancy to rise above it, we (like Cheerios) need to stick together.

Two years ago, nations across the world, most notably Japan, the U.S. and the E.U. engaged an ambitious agenda to reform the world’s financial markets and to bring transparency to the over-the-counter trading world. Countries set out to do that a little differently but all recognized that, in a global economy, a regulatory race to the bottom was in nobody’s best interest. The country with the thinnest rulebook shouldn’t be rewarded for holding regulatory fire sales.

Harmonization of regulatory regimes (sticking together) was to be a paramount goal. The problem today is that the work is not complete and there is temptation to do away with the very laws that were developed in reaction to the 2008 financial crisis and the all-to-close-to collapse of national economies. In the U.S., for example, there is a move afoot in Congress to repeal some or all of the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed only two years ago. Short of that goal, some would defund the very watchdogs which were given the rather Herculean task of keeping an eye on the Wall Street casinos. And, still others, including the casinos themselves, i.e. big banks, are choosing to fight the new regulations in court. Alas, just getting the rules in place is a immense challenge, let alone trying to harmonize them with other nations.

There is still great optimism, however. It may be a sad irony that the misfortunes of a couple big, global firms and their customers have re-energized those who trumpeted the need for financial reform in the first place. On June 18-19 in Los Cabos, Mexico, the G-20 will meet. Let’s hope for renewed energy there and at other venues where world leaders and financial regulators work to tackle problems that many have all too soon forgotten existed.

Regulators around the world need solid structures in place to avoid having to revert to crisis control when things go haywire—be it in European capitals or in the steel canyons of Wall Street. Like Cheerios, we need to stick together to get sound rules written; get them implemented; and, harmonize them across borders wherever possible.

Commissioner Bart Chilton of the U.S. Commodity Futures Trading Commission gave a speech in London on June 14 where he spoke about "The Cheerio Effect." He is also the author of "Ponzimonium: How Scam Artists Are Ripping Off America."