No solutions

This reminds me of Lucas critique.

Absolutely true. The same thing applies if you want to control your kids. But politicians are seldom good parents.

There is no adequate substitute for market discipline. The principal-agent problem abounds with all of this non-market “regulation”. They should kill off the FDIC so that depositors seek a dynamic market-driven form of regulation, such as a consumer reports for banks, and force banks to add Soundness to their list of things they advertise.

The combination of insurance, bailouts and thousands of regulators is the equivalent of the over-use of powerful antibiotics to the point of rendering them useless as the bugs become that much more virulent.

Banking, medicine and K-12 education are all dysfunctional for a reason, and it’s the thing they all have in common: hyper regulation and subsidy from the government.

Most people cannot conceive of a world without regulations. I can’t either. But I can conceive of a world that most would think ridiculously defunct of oversight.

We tend to view the world in terms of what exists now, instead of what could or should exist. A good economist never ignores the institutional framework, because it provides the incentives to which economic actors respond. A great economist, however, goes beyond the existing. He examines the institutional framework from a normative perspective. Why did the existing framework evolve? What political and business interests produced it? Can patches to the system improve it? Do we need a completely different approach to regulation?

A particularly incisive post on this comes from Cafe Hayek:

Thomas Sowell has said that economics helps you understand that there are no solutions, only tradeoffs. In that spirit, I want to recommend Arnold Kling’s study of the financial crisis, Not What They Had in Mind. My favorite quote from the essay is a variant on Sowell’s:

The lesson is that financial regulation is not like a math problem, where once you solve it the problem stays solved. Instead, a regulatory regime elicits responses from firms in the private sector. As financial institutions adapt to regulations, they seek to maximize returns within the regulatory constraints. This takes the institutions in the direction of constantly seeking to reduce the regulatory “tax” by pushing to amend rules and by coming up with practices that are within the letter of the rules but contrary to their spirit. This natural process of seeking to maximize profits places any regulatory regime under continual assault, so that over time the regime’s ability to prevent crises degrades.

The “Wisdom of Crowds” provides some insight as to why this occurs. Typically, a larger group of people is wiser than a smaller group. When the larger group (the industry being regulated) has financial incentives and the smaller group (the bureaucrats) have no financial interests (or limited in the sense of bribes, perquisites, future employment, etc), there is little hope for regulation succeeding. Either the regulatory body becomes “captured” or outsmarted.

Our regulatory focus is punitive. It is designed to build boxes based on “Thou shall nots.” Such an approach is always behind. It is always dealing with the last horse to escape from the barn. Such a strategy will always fail because of the innovation of business. Only a change in regulatory philosophy that is based on the free market as the policeman has any chance of working. The State mindset is unwilling or unable to recognize this. Hence we will move from one regulatory failure to the next.

"Instead, a regulatory regime elicits responses from firms in the private sector."

Which can lead to the consequences being worse off than what was originally in place.
It's Man's pride and hubris that thinks men can change the order of the universe to make everything "fair" and "equitable." The crisis is just one example of man tampering with things that are far to complex, creating a problem worse than the original.
The question remains, why do they keep on doing it. Why after the absolute failure of one set of regulations, do they think more will "fix" the problem? When the next crisis of our own making comes around, will they do this again and again?

Arnold complains: "If bankruptcy or some other form of resolution could take place quickly with clear rules for determining the priorities of various creditors, then there would be less incentive for creditors to rush to exercise claims on troubled institutions." Actually, this would spare the *senior* creditors from having to rush; but if the institution was thought to be insolvent rather than merely illiquid the *junior* creditors would have their accustomed incentive to run, hoping to get their money back in full before the institution declared bankruptcy, subjecting the other junior creditors to a haircut. But it may be unrealistic to call for a bankruptcy procedure that is *much* better than what we now have: our present procedure may be fairly close to the practicable optimum.

Arnold wrongly dismisses the possibility that easy monetary policy would have reduced the domino effect and the incentive for runs. After all, sufficiently easy money would have produced general inflation above trend, which would have kept even housing prices from falling very much (while other prices were increasing rather sharply). And it would have greatly reduced the rate of default by other borrowers besides mortgagees. This would have averted the financial crisis (caused by widespread actual and expected defaults).

@Russ Roberts: please WHERE "Thomas Sowell has said that economics helps you understand that there are no solutions, only tradeoffs"? Thanks.

try "A Conflict of Visions"

@AU03: thank you! :)

Yes -- it's in Sowell's 1987 book "A Conflict of Visions."

@DonBoudreaux: thank you! :)

With respect to @Randy and @Mommsen1625 the reaction of a corporate entity to government regulation may depend on the type of corporation. Technology and/or Industrial companies will likely see regulation as a gatekeeper protecting the established from new competition.

However our financial companies appear to have a vastly different outlook. Their history has demonstrated that they consider all activities legal unless the "rules" absolutely, positively, without question prohibit said activity. They hire very smart people who generally seek to find a rationale for conduct that isn't technically, strictly illegal.

"It depends on the definition of 'IS' "

I have no experience in that industry, but recent history does seem to support your point.

I think there's an underlying assumption in that excerpt that the new regulation is somehow beneficial and will solve the problem if everyone just followed the rule. That has not been my experience. Usually, regulators miss the mark on the "spirit". This is not surprising. I can only speak about the SEC, but that regulatory body is filled to the gills with people who haven't a clue how the financial products they are supposed to regulate work.

The only thing regulation does in practice is create distortions, additional expense and barriers to entry for competitors. I can't imagine what the dead weight loss from regulation is but I imagine it's huge. Yet, the protection regulation provides is pretty close to nil.

"This takes the institutions in the direction of constantly seeking to reduce the regulatory “tax” by pushing to amend rules and by coming up with practices that are within the letter of the rules but contrary to their spirit."

This may happen to some extent, but my experience working within corporations is that they tend to over respond, that is, to play it safe. The corporate regimes I have known are very politically correct. As I see it, the basic problem of regulation isn't so much that corporations try to get around it, but that it limits competition in that only large corporations have the ability to comply. Regulation protects, and this is the mechanism by which the regulatory tax is reduced.

As has been in argued in many places, we see the same thing with the campaign finance laws that liberals love so much. They favor large entities because they are the only bodies that can actually comply with them.

Happily it looks like that will be overturned based in significant part of the government coming out and saying that it is constitutional for them to ban books.

Happily it looks like that will be overturned based in significant part of the government coming out and saying that it is constitutional for them to ban books.

What????

The government (both the Obama and Bush administrations) argued that it could ban books under the circumstances discussed in the case; that apparently took much of the Supreme Court a back and they ordered a re-hearing. Many are predicting that they are going to overturn McCain-Feingold as a result of this.

That Hillary the movie case, what ever it's called. I hope McCain-Feingold is over turned. As long as it's in place we will only get a POTUS for the corporations by the corporations and paid for by the super rich.

OMG. Thank you for informing me. I didn't know that.

Some discussion of it here: http://www.firstamendmentcenter.org/analysis.as...

Here: http://www.ij.org/index.php?option=com_content&...

It surprises me that this story has received little MSM attention.

While we are at it, here is something else that has received little attention in the media: http://news.cnet.com/8301-13578_3-10320096-38.html