Regulation of Financial Markets

by Russ Roberts on February 5, 2009

in Financial Markets

Michael Smith comments over at EconTalk on a comment by one Mark K:

Mark K wrote:

These jokers on Wall Street, who according to Russ made
‘innovative’ products like credit default swaps, showed us unregulated
free market capitalism in all its glory.

The notion that we have an “unregulated free market” is false.

If we had an unregulated free market, the organizations and
individuals that made stupid investment decisions — those "jokers on
Wall Street" — would now be bankrupt, to be replaced by more competent
organizations and managers. Instead, under the current system, they are
“bailed out” — at your expense — and allowed to continue operating.

If we had an unregulated free market, the investment rating agencies
that rated securities containing subprime loans as “AAA” would be
disgraced, bankrupt and out of business — no one on earth would deal
with them any longer — they wouldn't be able to pay people to use
their services. Instead, under our current system, not only are all
those rating services still in business, the S.E.C. requires that all
issuers of investments use those rating agencies.

If we had an unregulated free market, no one would be forcing
bankers to make riskier loans than they wish to, as is currently done
by legislation such as the Community Reinvestment Act and threats of
lawsuits from organizations like ACORN and from the Federal
Government‘s Justice Department (Clinton‘s DOJ filed 13 major lawsuits
against banks for failure to lend to “minorities“).

If we had an unregulated free market, there would be no central
banking entity in charge of a fiat money supply with the ability to:

a) Make vast amounts of credit available at below-market interest rates.

b) Follow such a persistent policy of inflation as to convince
virtually everyone in the country that purchasing a house is “a good
investment”.

c) Eliminate ( or at least significantly reduce) risk aversion by
guaranteeing bankers that they (the Fed) will always be there as
“lender of last resort”.

d) Condone and make possible a preposterously over-leveraged
fractional reserve banking system under which banks currently hold
total reserves of only about 4% and are thus extremely vulnerable to
any sort of a run or loss of confidence in the bank.

If we had an unregulated free market there would be no
quasi-government entities like Fannie and Freddie and the FHA to insure
that trillions of dollars of that cheap credit made possible by the Fed
was directed into the residential housing market, producing an
unsustainable boom in housing construction, which, when it ends, leads
inevitably into an economic bust.

If we had an unregulated free market, the Federal Government would
not now be contemplating looting the American taxpayers of another
trillion dollars or so to pay off various special interests that helped
the latest collection of looters get into power.

We don’t have an unregulated free market. We have a “mixed economy”,
with a few elements of capitalism struggling under the weight of
literally thousands of pages of rules and regulations and dozens of
government agencies interfering in virtually every aspect of our
economic lives.

And under this set-up, it is you, the “little guy”, the individual
who doesn’t have a powerful lobby in Washington to get the rules bent
in your favor — you, who cannot command an audience with Congress to
beg for your personal bailout — you, who can do nothing as government
uses your funds to save the incompetent and the dishonest from the
consequences of their own actions — it is you who gets screwed.

We don’t have an unregulated free market; we have an out-of-control government intent on looting us blind.

My only quibble is the use of the word "intent." I see government malfeasance and error as a more emergent phenomenon rather than intentionally destructive. But other than that (and that is basically nothing), lots of wisdom here. Thank you, Michael.

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{ 48 comments }

Marcus February 5, 2009 at 6:26 pm

"Greed!" is a much easier answer. It frees one from having to think. It allows one to feel morally superior by blaming the 'bad guys'. It's a simple black and white dichotomy they can wrap their mind around. No need for shades of gray or complex human interactions.

Lee Kelly February 5, 2009 at 6:40 pm

Capitalism works when prices reflect underlying economic realities. The government has corrupted prices with inflation, subsidies, guaranteed debts, and malregulation. But garbage in, garbage out. When the government feeds in garbage prices, capitalism produces garbage outputs. Blame capitalism.

DAVE February 5, 2009 at 6:43 pm

stole my thunder

Mesa Econoguy February 5, 2009 at 7:09 pm

If financial markets were truly unregulated, I would have zero securities licenses, instead of 6.

And I would spend a lot less time worrying about what I can say to whom and how, and we wouldn’t have things like Rule 144a, 144k, Reg T, Reg NMS, Reg S, Reg G, Reg AB, Reg M, etc.

There also wouldn’t be rules against frontrunning; there would be no restrictions for instruments held only by “sophisticated” investors; there would be no Qualified Buyer, Qualified Institutional Buyer, and other designations; there would be no restriction on order flow and order routing; there would be no position limits on options, or standardized requirements for FLEX options; there would be no requirements for initiation & dissemination of quotes.

There also would be no Securities Act of 1933, Securities Exchange Act of 1934, Investment Company Act of 1940, Investment Advisors Act of 1940, Sarbanes-Oxley Act, Commodities Exchange Act, Bankruptcy Reform Act of 1978, Foreign Corrupt Practices Act (1977), RICO Act, Bank Holding Company Act (1956), Gramm-Leach-Bliley Act, Hart-Scott-Rodino Antitrust Improvements Act (1976), and Uniform Securities Acts of 1956,1985 (with 1988 Amendments), and 2002.

People who say financial markets are unregulated are uninformed idiots. Mark K is an uninformed idiot.

MnM February 5, 2009 at 7:20 pm

Wisdom from Michael Smith? NOOO! I refuse to believe it.

/sarcasm

Seriously, very well said, Mr. Smith.

dg lesvic February 5, 2009 at 7:21 pm

Mesa Econo Badguy

Bravo to you too!

What brilliant, well informed people we have here.

And thank you to our gracious and brilliant hosts for the whole thing.

Thank you all.

If we're going to go down, at least we'll know why.

TrUmPiT February 5, 2009 at 7:22 pm

My only quibble is the use of the word "loot." It's a tad harsh. I prefer the phrase "genteelly encumbered." I felt looted for the entire 8 years of Bush. Now that was highway robbery to the utmost. Is the honeymoon over for Obama? Even Bush enacted his infamous tax cuts for the rich without much hullabaloo. Where were the 200 liberal ecomomists to sign a Cato, Schmato petition condemning that looting of the poor and middle class? They were asleep at the switch for the most part while the looting of the treasury was going on. The rich owe us big time for the good times. First they refuse to fund government, then they crash and burn the system. I want them taxed and looted to pay for this economic collapse. The rich must be disparaged and pilloried and taught a lesson they'll never forget. MAKE THE STIMULUS $2,000,000,000,000 and send them bill by certified mail, and bill them for the postage as well.

Mezzanine February 5, 2009 at 7:24 pm

Mesa – it's all about the "big lie". Muirducks live to keep on perpetuating it, and 50.1%+ of the American people keep buying it! Heck even the film "Wall Street" by commie pinko Oliver Stone shows the bad guy being frog-marched by the SEC for insider trading! So how do muirducks get away with it?

Mezzanine February 5, 2009 at 7:26 pm

Muirduck – "Don't believe your lying eyes that we live in a heavily regulated economy! It's 100% free markets out there! Because I am the mighty Muirduck!!!!"

Mezzanine February 5, 2009 at 7:30 pm

TrUmPiT – it's OUR money. Instead of doing the Mother of all Porkapaloozas, let's just cut the tax rates and really stimulate the economy!

Mezzanine February 5, 2009 at 7:33 pm

Trumpit – let's stop looting the taxpayers, cut the damn tax rates and stimulate the economy!

Mezzanine February 5, 2009 at 7:37 pm

Sorry for the triple post, internet problems.

Bret February 5, 2009 at 8:08 pm

Mesa Econoguy wrote: "And I would spend a lot less time worrying about what I can say to whom and how…"

Is that true?

Would there be no lawsuits and lawyers in this world without regulation you describe? No guilds or associations with more or less equivalent private rules? No fraud?

Part of being careful of what you say is to try to avoid lawsuits. Part of dotting the government i's and t's is that if you follow the rules carefully you will reduce (but not eliminate) the odds of a successful suit against you. No?

Yes, the economy is heavily regulated.

No, your problems won't be all solved if the government were to stop regulating everything.

dg lesvic February 5, 2009 at 8:39 pm

Bret,

Don't quibble with our Bad Guy.

He did a great job.

Methinks February 5, 2009 at 9:00 pm

And under this set-up, it is you, the “little guy”, the individual who doesn’t have a powerful lobby in Washington to get the rules bent in your favor…

Bingo.

All regulation does in this industry is raise the barriers to entry, tilt the playing field toward the professionals, and force higher transactions costs on individual investors. And all that regulation is sold to the individual investor as "better protection" for him. I just laugh because the individual investor is usually all for this.

The regulating bodies will never be able to stop fraud just as the police cannot prevent murder. At best, the regulator functions as the police. At worst, it dictates how business is done – usually to the detriment of the customer.

With fewer regulations there will be fewer lawsuits, Bret. Investors often file suits even if they can't win them and that's costly for investment pools because there are many investors per one pool. You don't have to lose a lawsuit for it to be expensive. That means that really good money managers severely limit the type of investor they will accept, leaving only mediocre and bad managers open to accepting the least qualified investors. Private rules are different because you can't use them as a basis for a lawsuit.

The "qualified investors" that Mesa is talking about are people who either make $200K per year or have $1MM in investable assets. This wealth test is supposed to weed out the investors who understand finance well enough to invest in securities offering (any investment in a trading partnership or hedge fund is also considered a securities offering). That means that a professor of computational finance may not be "qualified" to make investment decisions for himself while Paris Hilton is…like TOTALLY qualified to make financial decisions for herself. That's HOT. It's a better legal risk for me to take Paris. I won't take a lawyer.

But Mesa's larger point is that there is a swamp of idiotic regulations. So, the financial markets are ridiculously over-regulated. I'm saying that the industry long ago captured the regulators and is using the regulators

Methinks February 5, 2009 at 9:09 pm

sorry, hit "post"

…to write rules to screw the customer. And the favourite customer to screw is always the individual investor. The one the regulators are supposed to protect.

The uptick rule? All the market makers and professional traders loved it and are desperate to have it back. It only ever inconvenienced Joe Blow retail guy, but market makers could totally use the fact that rule reduced competition in making markets to rape Joe on his orders. I've argued forever that the rule tilts the playing field and screws Joe. But, you know who wants it back? Joe Blow. I'm tired of fighting.

The restrictions on short sales? No problem. Market makers were exempt. When they took the exemption away from options market makers, a bunch of firms refused to make markets. Bid/ask spreads (the transactions costs the customer pays) were so wide you could house an evicted family of five in them. The boycott was successful, within two days options market makers got their exemptions back. Other pros just went to the options market and still smarter pros even bought stock via combos because the short prohibition had the effect of driving the stock price lower in the options market than in the stock market.

So, Bret, OUR problems in the broker dealer industry are really just keeping good lawyers and accountants to comply with the sea of silly regulations. That's not a problem since the regulators are good enough to tilt the field so heavily in our favour. The regulations are really YOUR problem as they screw you.

Methinks February 5, 2009 at 9:17 pm

Private rules are different because you can't use them as a basis for a lawsuit.

Let me clarify….a breach of a private contract can always be used as a basis of a lawsuit. But in a private contract, the parties can choose the contents of the contract. Not so with regulation.

snguyen February 5, 2009 at 9:28 pm

I often wonder how those who claim that more regulation would have forestalled this crisis, account for Freddie and Fannie. The two GSEs after all had an agency solely devoted to regulating them. The head of this agency was saying no more than 6 months before their receivership that both agencies were well capitalized.

If one regulatory agency can not effectively regulate two companies, what will they suggest? Each company has its own regulatory agency?

Mesa Econoguy February 5, 2009 at 9:38 pm

Bret, the number & scope of regulations in financial markets can lead to contradictory directives. Suffice it to say, there are so many financial market rules, some of them conflict, and more are about to do so.

I’m not making the assertion that we should have no rules (the most common anti-libertarian straw man), only that the large number of extant rules is onerous, and about to become draconian (and self-contradictory in many places).

And that people who say financial markets are unregulated are morons who have no idea what they’re talking about.

Mesa Econoguy February 5, 2009 at 9:41 pm

And everything Methinks just said. Outstanding points, all.

Jon February 5, 2009 at 9:58 pm

With all due respect, how does anyone know what would happen if we had an "unregulated free market"? Why should we expect our models of economic behavior to hold if we swept away the institutional framework in which they are embedded?

A better question might be, "Would we benefit from more financial regulation at the margin?" Recent events suggest that the answer is yes.

Methinks February 5, 2009 at 10:38 pm

Jon,

What regulation would have prevented "recent events"?

Recent events tell you that regulation and the associated government intervention – specifically in the form of government guarantees – encouraged market participants to behave in ways and in amounts they otherwise wouldn't have. This suggests that there is too much regulation and other government interference. It's skewing decision making toward more risk and away from prudence.

Don't confuse rule of law and regulation. Lack of regulation does not mean that contract law suddenly evaporates. It doesn't mean that fraud suddenly becomes legal. What it does mean is that there will be more competition and more competition is better for the customer.

Even seemingly innocuous rules like disclosure are only effective in lulling investors into a sense of over-confidence. After all, everyone is regulated and everything is disclosed. Right? Fraud is never disclosed and is almost impossible for regulators to detect. Neither is incompetence. Nor is a disregard for risk – even if that's disclosed, most investors don't understand risk management. Why would they? Half the industry doesn't. If companies have to compete for investors, they will either lay bare what the investor demands or the investor won't invest. More competition means more companies will be willing to disclose more information sans regulation. Our industry is insulated by regulations to the point where we don't have to be very competitive. That's not good for you because you still get stuck paying for the fraud and the poor risk management (we have political action committees and lobby groups and you don't) but you also pay the cost of regulation along the way. It seems you're overpaying for protection now.

I should note that my company neither needs nor is illegible (hopefully) for any bailouts, so I'm using the term "we" very broadly.

Methinks February 5, 2009 at 10:40 pm

Thanks, Mesa.

RickC February 5, 2009 at 10:49 pm

Methinks,

Nice response to Jon.

RickC February 5, 2009 at 10:51 pm

Methinks,

Nice response to Jon.

Different Jon February 5, 2009 at 11:25 pm

I want to hear the wise commenters' (and bloggers') thoughts on Smith's assertion that the 4% reserve ratio that the FRB requires banks to meet wouldn't exist in an unregulated market.

Obviously some would go lower, some higher, quibble over the number, etc. I'm not interested in that.

I claim deposit insurance is a useful service that someone would provide, thus permitting banks to hold fractional reserves. (Banks could try without it, but would be highly susceptible to runs. DI — regardless of its provider — alleviates that.) Thoughts?

Lee Kelly February 6, 2009 at 1:17 am

Although I object to the way that fractional reserve banks actually operate, I see no problem with them in principle. The common libertarian opposition to fractional reserve banking is confusing to me.

Fractional reserve banks should operate like a cross between and investment company and a 100% reserve bank. That is, some of the money is on hand for depositors to withdraw, and some is used to invest. In a free market, fractional reserve banks could advertise their reserve ratio to indicate risk and reward.

The issuing of loans would also need to change. Banks should issue loans in a special or marked currency of some kind. The purpose would be to prevent other banks from obtaining that money and making more loans against it. Otherwise the banking system creates more loanable funds than there are loanable resources to back it up.

But other than that, I do not understand the problem.

Jacob Oost February 6, 2009 at 1:41 am

Somebody send this to Krugman and Delong.

Bret February 6, 2009 at 1:42 am

Methinks wrote: "With fewer regulations there will be fewer lawsuits…"

I doubt it. There will still be lawyers, won't there? Private entities (people and businesses) sue each other all of the time and they always will, even over completely unregulated things.

Methinks also wrote: "This wealth test is supposed to weed out the investors who understand finance…"

You seem to have a Series 7 so you know your statement is misleading at best. While qualified investors are also sometimes known as "sophisticated investors", the rule is mainly intended to prevent those who can't afford to sustain significant losses from investing in highly risky investments.

Methinks also wrote: "It's a better legal risk for me to take Paris."

Paris can probably afford to sustain some losses in some risky investments.

Methinks also wrote: "…OUR problems in the broker dealer industry…"

I had a Series 3 for many years so I'm well aware of the problems in the broker dealer industry.

Those problems won't evaporate if the government stops regulating the industry as long as there are still lawyers. I'm not saying the current regulations are very good, but I think that you'd find a completely unregulated environment would be hugely challenging in different ways.

muirgeo February 6, 2009 at 3:01 am

With all due respect, how does anyone know what would happen if we had an "unregulated free market"?

Posted by: Jon

It's called faith Jon. They are heavily invested in it and are quite obviously completely unable to answer your excellent question.

Jacob Oost February 6, 2009 at 4:51 am

You mean I have "faith" that high prices attract investors, leading to a greater supply and lower prices? Or do I have evidence?

The problem is, we know how the market works, but some people, for some reason, don't trust it to work the way we know it does. Outside the universally agreed upon roles for government (natural monopolies, externalities, etc.) there are many proscribed roles for the government that are nothing more than symptomatic treatments for short-term problems. They *may* achieve the desired result in the short-term, but they will cause long-term inflexibility and competition and lack of freedom in the economy.

ivan February 6, 2009 at 5:09 am

I don't agree with his views concerning the rating agencies. Even in an unregulated free market they have their role, I would almost say, even in an unregulated free market their role is essential. If a bank gives a loan it can judge for itself how risky the loan is. But if loans are repackaged into securities like collatoral debt obligations the bank has to rely on rating agencies. The real question, I think, is the following. How big would securitization have become in an unregulated free market?

vidyohs February 6, 2009 at 7:05 am

ivan,

Consider this, perhaps in the unregulated free market Methinks and Mesa Econoguy speak of there would be no unexamined fraudulent bundling of loans into securities because people are now, and would be, too knowledgeable to take on the risk. Without government guarantees, why would anyone touch what is now known widely as toxic paper? That's the sensible option a free unregulated market brings.

To take it a step farther, if there were bundling of loans into securities, the people in the free market would be well aware of the risk and be in a position to take them, sans government guarantees, on if they chose.

I don't know if that is a good answer but it makes sense to me.

I'll hang up and listen while Methinks or Mesa speak to the issue.

Bill Woolsey February 6, 2009 at 7:17 am

To me, the response here confused "leverage" which has to do with capital and fractional reserve banking, which has to do with reserves. I am pretty sure that 4% refers to the capital ratio of investment banks, not the reserve ratio of commercial banks. The required reserve ratio against "official" transactions balances is higher than 4% (more or less 10%.) Today, the actual ratio is greater than 100%. However, transactions accounts are only about 1/6 of total bank deposits, so these required reserves are pretty small compared to total deposits. Capital requirements for commercial banks are more or less 10%.

The investment banks didn't have those capital requirements. They didn't have transactions accounts at all and so no reserve requirements.

vidyohs February 6, 2009 at 7:28 am

muirduck,

As usual you are dead wrong.

"With all due respect, how does anyone know what would happen if we had an "unregulated free market"?
Posted by: Jon

It's called faith Jon. They are heavily invested in it and are quite obviously completely unable to answer your excellent question.
Posted by: muirgeo | Feb 6, 2009 3:01:13 AM"

I am not qualified to speak on the levels of some of the upthread participants, people whose opinions I value and trust; but, on this issue I am as qualified as anyone because answering Jon's question doesn't involve detailed knowledge of economics nor of financial markets. It involves knowing what really bothers yee evangelicals of the Socialist Church.

As a matter of fact Jon's question has been answered in your mind over and over again, you are just too stupid to recognize it.

Jon may be a newcomer to life, so I can't speak to his motivation for asking the question, I will address him and you as if he was indeed asking a sincere question and not just a rhetorical one.

From the archives of Stupdidity of the Duck:

"4. “Planning and tinkering will definitely have a place in creating a strong competitive market. The invisible hand……YOU'RE FIRED!!!… well or at least demoted.”
Posted by: muirgeo | Mar 17, 2008 9:13:45 AM

Remember that one muirduck? Remember the invisible hand that you don't want anything to do with?

Jon's answer is just that. When you deregulate and free up the markets, no one can predict what will happen. That is when the invisible hand steps in and begins to rule once more. A free market is a fluid market and will shift and change not just on a daily basis; but, as current communications and rapid delivery have shown, the market can shift and flow virtually instantaneously. It does that because the invisible hand is you and I, and our wants, needs, and desires change rapidly and unpredictably (at least my wife's does).

There is Jon's answer.

And, the point that you stupid socialist absolutely refuse to see is that for all the fluid nature of the markets, the shifting changing way things are done in a totally unplanned and uncontrolled way actually makes it much more efficient and profitable for everyone involved.

The only way Jon can not benefit more from a free market, as opposed to a regulated market, is to not participate.

Now to close this out, my little socialist duckie. The reason you evangelicals and priests of the socialist church hate free markets so much is in the word "change". For all the labels you assume, and are then privileged by the media to wear (such as liberal or progressive), the fact is well known by people of intelligence that socialist hate change most of all things because change is not predictable nor is it controlable. Change will bring things no one can anticiapate or plan for. Change, to a socialist is an immediate loss of control, change will not be tolerated.

Socialism is about total top down control and change is not allowed under the system. That socialism equates to stagnation is a lesson than anyone with intellect can learn simply by observing and studying history. Every single place it has ruled, the people slowly are brought to desperation because of the choking stagnating nature of socialist laws and regulations. Those laws and regulations stifle innovation, ambition, and productivity.

There are your answers, muirduck. And, least you think this post was actually aimed at educating you, my little duckie, forget it, I know I am talking to a tape deck when I address you. This post was for Jon, assuming he was sincere rather than rhetorical.

Methinks February 6, 2009 at 8:58 am

I doubt it. There will still be lawyers, won't there? Private entities (people and businesses) sue each other all of the time and they always will, even over completely unregulated things.

Bret, regulations are so onerous and there are so many of them, that it's very easy to be in breach of some tiny regulation or another. In fact, the SEC, FINRA & CFTA regularly have to overlook minor infractions or 99% of firms would be shut down. For lawyers, a minor infraction is a basis for a lawsuit. Fewer little things to be in violation of means fewer grounds for lawsuits. I never said there would be NO lawsuits, just fewer.

You seem to have a Series 7 so you know your statement is misleading at best. While qualified investors are also sometimes known as "sophisticated investors", the rule is mainly intended to prevent those who can't afford to sustain significant losses from investing in highly risky investments.

You seem to mistake the intention of a regulation with what actually happens. First of all, there is an assumption that any investment in anything that is not a mutual fund is "high risk". That's wrong. Second, the finance professor is much less likely to invest a significant portion of his investment capital with a single manager because he would know the basics of diversification. As painfully illustrated by the Madoff case, unsophisticated rich investors make that mistake all the time. Can anyone afford to lose 99% of their retirement capital? Even though Paris is rich, she's much more likely to lose all of her money by making uninformed investment mistakes than the less wealthy finance professor. That doesn't spell "sophisticated" to me.

All this regulation does is remove the investment decision from the individual investor. What right does the state have to dictate which investments are right for which investor?

Paris can probably afford to sustain some losses in some risky investments.

Paris is far less likely to understand how risky the investment is. I know plenty of trading partnerships which have made a lot of money last year while the "safe" mutual funds lost over 50% last year. Those trading partnerships were able to hedge in ways that I don't think mutual funds even can and they understand and manage risk much better than mutual funds. You have to be a qualified investor to invest in a trading partnership but not a mutual fund. Paris wouldn't even begin to know know how to spell "hedge", let alone know what that is. The finance professor, though poorer, is much more likely to assess risk better and not to put all his eggs in one basket.

Methinks also wrote: "…OUR problems in the broker dealer industry…"

I had a Series 3 for many years so I'm well aware of the problems in the broker dealer industry.

Those problems won't evaporate if the government stops regulating the industry as long as there are still lawyers. I'm not saying the current regulations are very good, but I think that you'd find a completely unregulated environment would be hugely challenging in different ways.

Way to miss my point by parsing my sentence, Bret. My point is that regulations create very few "problems" for us. They're a nuisance. They create problems for retail customers because they lull them into a sense of false security and significantly raise transactions costs. I don't know why you think problems have to evaporate for things to be better. Nobody is looking for Utopia. The fact is that almost all regulation forces customers to WAY overpay for protection they don't actually get. A less regulated industry would be HUGELY challenging – it would force lazy firms to actually COMPETE instead of collecting economic rents. I've said before that I prefer this because it's more fair to all market participants and I'm just arrogant enough to think that I can compete without the regulators creating rents for me at the small price of filing monthly reports with my regulators. Competition is always challenging, but it also produces the best results.

Martin Brock February 6, 2009 at 9:28 am

Jon:

With all due respect, how does anyone know what would happen if we had an "unregulated free market"?

"Unregulated market" is a contradiction in terms.

Muirgeo:

It's called faith Jon. They are heavily invested in it and are quite obviously completely unable to answer your excellent question.

Like your faith in central committeemen doling out a trillion bucks from the top of an incredibly rigid pyramid of established authorities involves no blind faith. I can hardly imagine a blinder faith.

Hammer February 6, 2009 at 9:35 am

Trumpit: "The rich must be disparaged and pilloried and taught a lesson they'll never forget."

If he added "Except those that fight for progress and equality!" that would pretty well sum up the entirety of leftist/socialist thinking over the course of history. The rich are bad because they are rich.

Substitute any other random grouping of people for the word "rich", say blacks, Jews, Scythians, gays, women, or whatever, in what Trumpit says, and you have the basis for every drop of institutional, cultural wide evil humanity has cooked up.

Look upon his words, and see the face of evil.

muirgeo February 6, 2009 at 9:52 am

You mean I have "faith" that high prices attract investors, leading to a greater supply and lower prices? Or do I have evidence?

Posted by: Jacob Oost

You want to expound on that or explain it in a little more detail because what you wrote made NO sense to me. High prices of what???

You mean you buy stuff because it's expensive?? Huh??

Investors don't supply if there is no demand.

muirgeo February 6, 2009 at 10:10 am

Like your faith in central committeemen doling out a trillion bucks from the top of an incredibly rigid pyramid of established authorities involves no blind faith. I can hardly imagine a blinder faith.

Posted by: Martin Brock

My faith is not blind. I've got the results of poorly regulated markets from the turn of the century through the 1920's and the end results… I've got the well regulated markets from the mid 30's through the early 80's with nearly 50 years of excellent growth. Now I've got the poorly regulated markets since Reagan and I'm looking around at the results.

That's not faith. It's evidence and facts. I'm a pragmatist, a realist… you guys choose to ignore the data and have faith in something that doesn't exist and for which you can support no evidence. You like neatness so you come up with a simple neat little idea and assume the real world should be so as well. Hint the real world is messy and complex.

You guys have ideas that we all want to believe in. Heck I want to believe in your ideas. I would love it if life was as simple as saying no rules is always the best policy, I want to believe that their is a just God and a pretty little place called heaven but their is no evidence for it so no reason for me to have faith.

Your argument quite simply is like claiming heaven would be a better way to run the economy then having all these rules and regulations. Well sure it would be… if it existed.

Methinks February 6, 2009 at 10:24 am

what you wrote made NO sense to me. – Muirdiot

Shocking.

Then he goes on to illustrate just how stupid he is:

I would love it if life was as simple as saying no rules is always the best policy

If you missed this show, don't worry. He'll repeat it on every single thread.

David February 6, 2009 at 10:31 am

Whenever I want to tear my hair out whenever I hear commentators on TV Bush unregulated economy or tax cuts don't work. They increased revenue but bush spent more. It was the excessive spending of government backed Fannie Mae that created the crisis.

If a deregulation was the cause of the problem what laws did Bush eliminate?

Bush passed more regulations than any president not named Richard Nixon. He passed Sarbanes Oxley the largest financial regulation in the past 50 years.

Jon February 6, 2009 at 11:27 am

Methinks writes: "Don't confuse rule of law and regulation."

Government regulation of a behavior is equivalent to levying a tax on that behavior. There are two variables that determine the size of the tax — expected punishment, and expected probability of being caught. Regulations are laws like any other, that prescribe penalties for certain behaviors. Enforcement by regulatory bodies can increase the probability of being caught. Unless your concept of "rule of law" does not include the enforcement of penalties for certain behaviors, then I don't understand the distinction you're trying to draw.

You seem to agree that there were bad incentives at work in creating the current crisis; however, you seem to believe that these bad incentives were created by the government, and so are not market processes. I'm not sure how you can disentangle the sources of the incentives operating in a regulated market. The market-government dichotomy is somewhat arbitrary, because markets only exist as embedded in a social institutional framework, and government is part of our framework. In my view, the proper discussion is how government action will affect incentives at the margin.

This marginal action can take the form of relaxing regulations and enforcement, or of creating new regulations and increasing enforcement. You seem to believe that decreasing regulations would represent a marginal improvement, and single out government guarantees as a major source of the current crisis.

Jon February 6, 2009 at 11:27 am

Methinks writes: "Recent events tell you that regulation and the associated government intervention – specifically in the form of government guarantees – encouraged market participants to behave in ways and in amounts they otherwise wouldn't have."

If I'm reading you right, you're arguing that the primary source of the crisis were implicit guarantees of large financial companies, which created moral hazard by effectively mitigated the market penalties for poor pricing of risk. Your proposed solution is to restore market penalties by letting financial companies fail, regardless of the systemic effects.

I don't think that that letting these companies fail is politically realistic or economically advisable. In my view, the best solution at the margin is to legally increase penalties on excessive risk-taking by increasing enforcement, and creating additional regulations for this action. However, I agree that this question is not clear-cut, and it's perfectly valid to discuss.

What I think is invalid is to appeal to a the utopian udeal of an unregulated free market, as in the comment originally quoted in this post. Unregulated free markets may be subjects of speculation, but they are not open to empirical study since all our conclusions about economic activity are based on observing human beings interacting in markets embedded in social institutions. We have extensively studied how marginal changes in this institutional framework affect incentives, but I do not believe that naively applying these conclusions to a theoretical econ 101 market represents a valid inference.

Jon February 6, 2009 at 11:27 am

Vidyohs writes: "A free market is a fluid market and will shift and change not just on a daily basis; but, as current communications and rapid delivery have shown, the market can shift and flow virtually instantaneously."

You are quite correct that markets coordinate economic activity through price signals. However, these prices are not perfectly flexible, nor is their communication instantaneous. Rather, prices propagate through a differential social medium, and many institutions facilitate and regulate this process. Markets are a valuable tool to coordinate human activity, since price signals allow them to respond to shocks much more quickly and efficiently than a centrally planned government. However, they are vulnerable to unanticipated shocks, or shocks that require unusual levels of coordination to optimally address. In these cases, central coordination can be beneficial, or else institutional changes to correct bad incentives.

Jon February 6, 2009 at 11:27 am

Martin Brock writes: "'Unregulated market' is a contradiction in terms."

Precisely my point. We should speak of marginal changes in regulation to the institutions in which our current regulated market system is embedded, rather than speculating about what would happen in an "unregulated free market."

Methinks February 6, 2009 at 11:45 am

If I'm reading you right, you're arguing that the primary source of the crisis were implicit guarantees of large financial companies, which created moral hazard by effectively mitigated the market penalties for poor pricing of risk. Your proposed solution is to restore market penalties by letting financial companies fail, regardless of the systemic effects. – Jon

Yes, you're reading me right. If the system is so bad that firms can't fail, then the system is bad and needs to be scrapped.

I agree that allowing large companies to fail is politically impossible because the politicians are the reason these companies got so big and sloppy in the first place. They have bought the regulator and they have bought the politicians.

In my view, the best solution at the margin is to legally increase penalties on excessive risk-taking by increasing enforcement, and creating additional regulations for this action.

Pretty easy to make nebulous sweeping statements. Enforcement of what? You never answered the question of what new regulation would have prevented this. What regulation would stop a company from lending to someone who will never be able to pay it back when the government itself is trying to encourage such lending with guarantees? And if you have such guarantees, what's the point of regulation to prevent companies from complying with them. Further, you don't actually need additional legal remedy for too much risk taking. What deterrent is more powerful than bankruptcy and investor lawsuits? You could, I suppose, add jail time for taking "too much risk". But, "too much risk" is so subjective, that the bigger risk is that nobody will take the risk of starting a business and that will tank the economy.

What I think is invalid is to appeal to a the utopian udeal of an unregulated free market,

I agree, so please stop doing it. This straw man is built and shot down by interventionists. Utopia has never been a promise of free markets. I never promised Utopia with a free market, I merely point out it's the better alternative and that government intervention skews incentives so that we no longer have natural consequences and we increase the propensity for catastrophic failures. The government is well suited for maintaining rule of law and it should stick to that. It is interventionists who believe in the possibility of Utopia through government intervention.

Unregulated free markets may be subjects of speculation, but they are not open to empirical study since all our conclusions about economic activity are based on observing human beings interacting in markets embedded in social institutions.

Another straw man. Why do you insist on conflating "regulation" and "rule of law"? This is at least the third time on this thread that I've remarked on this. Nobody is arguing for anarchy.

Methinks February 6, 2009 at 12:27 pm

Unless your concept of "rule of law" does not include the enforcement of penalties for certain behaviors, then I don't understand the distinction you're trying to draw.

The distinction is that rule of law is not arbitrary and regulation is. It has long been known in the industry that if you're politically connected (as Madoff was) or too small, the regulators won't bother with you. That's arbitrary. Further, regulations are not laws. There is an endless list of regulations that are incompatible with law and can result in fines and expulsion from the industry but no breech of law. For example, the SEC has recently adopted a regulation that intent is no longer necessary to prove fraud. This an arbitrary ruling will never stand up to legal challenge, but the SEC can bring action against people and businesses based on this arbitrary and nonsensical rule. It can even drive a small business, without funds to take up a legal challenge, out of business. Michael Milken wasn't driven out of the industry for insider trading. There was never any evidence of that. Instead, his was driven out of the industry for "parking securities". Regulations prohibit this activity but EVERY broker dealer on Wall Street did it back then and continued to do it after Milken's expulsion. The choice to drive Milken out of the industry to raise Giuliani's political profile was completely arbitrary and is the antithesis of Rule of Law.

The market-government dichotomy is somewhat arbitrary, because markets only exist as embedded in a social institutional framework, and government is part of our framework.

Again, don't confuse the arbitrary framework of regulation with the government enforced rule of law. One of the definitions of rule of law is that it is not arbitrary. Having government as part of our framework doesn't mean that having regulation is.

In my view, the proper discussion is how government action will affect incentives at the margin.

OK. Please think through how government actions will affect incentives at the margin when large firms buy regulators and politicians who then rob shareholders to prop up said companies when those large firms lend money to people who are not credit worthy but that the government wants them to lend money to by encouraging them with guarantees and legal threats. Without government intervention, who would lend money to someone without making sure they can pay it back? And if they did, would they last long enough to be able to grow "too big to fail"? I doubt it.

Also, please explain to me how restricting everyone but market makers from shorting stock doesn't reduce price competition, liquidity and raise cost of capital for companies and transactions costs for investors. Liquidity and all that flows from it is the primary benefit of a public market. The benefit of this regulation to the market is zero. The cost is tremendous. That's just one example and there are many others like it. How much do you think we're benefiting from regulations that cost more than the benefit they provide?

As I think about your posts in aggregate, I realize everything you write is based on a single naive assumption – the regulator is acting in the best interest of the public. You're wrong. The regulator is acting in the best interests of industry insiders. All of the regulatory bodies of the financial markets have long ago been captured by the industry and work only in their interests. That the insurance industry as well and probably other industries with which I'm less familiar. We should be writing "wise regulation" which increases protection of the public by more than the cost of that protection, but that never happens because industry insiders always insure it won't and the regulator's job depends on the industry. "wise regulation" is the real contradiction in terms.

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