The Case Against Re-Regulation

Deregulation! It is continuously the culprit of today’s global financial predicament. The word rings through the media under the harsh criticism of a thousand voices. It heralds free market economics, but it has lately been associated with the failure of the Greenspan era at the Federal Reserve, leading up to what has been the worst financial debacle in the history of the modern international financial system.

Deregulation, however, is not the issue. It is an unfortunate victim of a crucial misunderstanding of players in this crisis of confidence, capital and corruption. Deregulation is a misnomer created by politicians and media players who misunderstand the core principles of the situation at hand.

What has ultimately led to the simultaneous collapse of both the credit bubble and real estate bubble was poorly practiced central banking, a lack of regulatory action, and a culture of greed.

In the United States, the Federal Reserve is the institution solely responsible for maintaining financial order. To accomplish this task, it has several tools at hand including setting monetary targets through the federal funds rate or exchange rate targets, and controlling national money supply by buying and selling government securities or other financial instruments.

If you are in any way involved in the argument for or against free market economics, you must realize that the presence of a central bank in an economy automatically restricts free market activity. When there is an attempt to control the value of the market’s currency through “open market operations”, the invisible hand is restricted from doing its work.

Through the Greenspan era, the Federal Reserve held the federal funds rate, an indicator that influences national interest rate levels, at an extremely low level following the collapse of the technology bubble. Recently, Bernanke has been terrifyingly active in flooding the market with fresh greenbacks in order to attempt to “generate confidence”. This is more strongly associated to further regulation.

Followers of this financial catastrophe have also come to the realization that the SEC, the CFTC and their fellow government regulatory bodies failed to see any of this coming. The reason for this is simply because they failed at doing their jobs. The ratings agencies, especially, although not government sponsored, simply turned their backs on the malinvestments that banks were making in the mortgage market.

They looked into bankers’ eyes, saw the greed and lust for profits, interpreted it as profound understanding of everything financial, and completely failed at accurately analyzing the risk associated with investments. At the same time, the SEC, CFTC and various other government watchdogs simply looked the other way, refusing to actually monitor the insane amounts of leverage that banks were building in investments that fundamentally made little sense. This is called ignorance, and has nothing to do with regulation or deregulation.

Finally, the culture of greed. Wall Street epitomized its name in the self-titled film starring Gordon Gekko, a character who defined a generation of businessmen and aided in making greed acceptable. Unfortunately, you cannot have greed without the other vices of contempt, collusion and corruption. They come hand in hand, and they have made themselves known in the US financial system as bedfellows.

Wall Street has sidled up next to the US government, filled politicians eyes with success measured by wealth, and won their hearts and minds. The children of this relationship: Hank Paulson and Tim Geithner as treasury secretaries. We are faced with the possibility of corruption at the deepest level, when the appointed officials were former employers of the institutions they are to regulate. This has undoubtedly resulted in a skewing of what should be a free market, and played no small part in the safety net that has protected many of these institutions from the “perils of bankruptcy”.

The American people are searching for the culprit to their problems. In this search, the media screams in their ears, “Deregulation is evil, we must regulate.” Although some may think this an oversimplification, the will is not present to continue the search when a plausible answer seems to be at hand. It’s as if we are playing an orchestra, trying to come into tune, and the government says to us, “We need more musicians”, failing to realize what we have is plenty. How we play our parts is what is important.

The issue at hand cannot be measured in terms of regulation, it is not that simple. The answer is more accurate regulation by the regulatory watchdogs in place – they must do their job correctly and efficiently. The answer is sound central banking without massive fluctuation in interest rates that wreck havoc on investor and corporate confidence. The answer is corporate social responsibility based on moral business decisions with the interest of the entire economy in mind.

Comments

[Jim Hawthorne:]

Ah, yes! Put the foxes back in charge of the hen-house and let the arsonists run the fire department!

You write that, "The answer is corporate social responsibility based on moral business decisions with the interest of the entire economy in mind."

You seem to be advocating a sort of "faith-based" economic system relying upon a corporate leadership elite totally made over and remodeled; sort of a bizarre version of the 'Stepford Wives'?

Yes, there was poor oversight; there was also blind faith in Adam Smith's 'unseen hand', and a mistaken notion that deregulated markets would 'naturally' regulate themselves. Please, don't set us up for a sequel!

Apr 16 09:11 AM

[Larrysyr:]

I was with you till that last sentence.

In any free market, the participants act in their own self-interest. Where that coincides with morality and social responsibility, great. Where there is a conflict, the participants are not likely to intentionally take lower profits simply for the benefit of the entire economy. Executives who do this tend to end up unemployed.

The purpose of regulations is to align self-interest more closely with societal interest. You are quite correct that regulators failed to do their jobs and helped to precipitate this crisis. I think you're wrong to think that businesses left to their own devices will act altruistically.

Apr 16 11:13 AM

[sether:]

Self interest and the common good are mutually exclusive concepts, and an oxymoronic duality when applied to economics. Please stop with the "Invisible Hand" nonsense. You Rand/Smith acolytes are infantile in your evangelical belief in this purile hocus pocus. It's no better than a cult; whose cynical leaders unfortunately also controlled our economic policy, and forced us all to drink the kool-aid, willing or not. Much carnage resulted. How many more contrived boom/bust cycles and bailouts must we endure before people stop pumping unregulated capitalism? Lose that religion folks.

Apr 16 01:40 PM

[William Cowie:]

Adam Smith held that self-interest will lead to the common good through what he termed "the invisible hand." That is true, but only in an environment of open competition. In his definition, everyone pursues self-interest in submission to the rules of free competition. He didn't reckon with John D. Rockefeller and John P. Morgan who pursued self-interest by killing competition through means legal or not. The government recognized this (a little too late, but they can hardly be blamed for that) and responded with the beginnings of what we have come to call regulation.

For sixty years or so, this worked fine. Over that time, criticism began to mount at the two poster children for inefficiency protected by regulation, AT&T and the airline industry. And so deregulation became the new vogue: AT&T was broken up into the long distance company and the Baby Bells as local monopolies. The airline industry was not a monopoly, so there wasn't one company to break up. Instead, all restrictions to competition were lifted. In both cases, the purpose of deregulation was a sound one: increase competition to enable Adam Smith's invisible hand to achieve the common good. In both cases, deregulation achieved its purpose in stellar fashion. I remember in 1980 making a transcontinental phone call for $4.00 for 3 minutes. How that cost has fallen! Likewise for air fares. Deregulation achieving common good, without any question.

However, not all regulation was bad, i.e. created inefficiency. This is a crucial piece of information.

Two other notable examples from the regulation era were broadcasting companies and banks. In both cases, the purpose of regulation was to limit the power of individuals or groups to squash competition and to promote their agenda at the expense of others, who were powerless to defend themselves. Those regulations worked, because they fostered open competition.

So the important point is to note that not all regulation is the same. Some regulation inhibited competition, and some regulation fostered it. Therefore, in some cases deregulation was (is) a good thing. In other cases, however, the opposite is true.

So we need to be careful when generalizing about whether deregulation is a good or a bad thing; it depends on which industry we're talking about.

History has taught us that regulation (or deregulation) which increases competition creates the classic (and desirable) situation of self-interest achieving the common good. It has also taught us (and continues to teach us) that regulation or deregulation which kills competition can only hurt us. It will benefit the monopolists, to be sure, but it will not achieve the common good.

Our government, for the most part, understood this, especially after the Great Depression, and gave us the most efficient economy in the world, the envy of all.

But then something changed. It started with the media. They recognized that elections could become a great boost to their earnings. And so they created an environment where the candidate that spent the most money on advertising in their media would win the presidency. This, of course, trickles down to all levels of public office. And they made sure that all politicians knew this. When they reported that candidate X won, they were very clear that candidate X spent y amount of dollars. In other words, they (the media) were the new kingmakers.

Newspapers and television stations make every election appear closer that it really is, in order to convince every candidate they need to spend every last dollar they can. (In passing, we note that all the newspaper closings happened AFTER a presidential election, when that great market went away, as it does every four years.)

Media spending to get elected served the interests of the media very well. If you look at a chart of political campaign advertising both as a percentage of all advertising and in absolute dollars, it was probably their best market. So they chased it for all their worth.

However, in so doing, they created a society where any aspiring politician needed cash more than anything else. No matter how competent you are, no matter how good your agenda is for the nation, without cash to spend on media advertising, you have no chance at election. Furthermore, no matter how incompetent or corrupt you are, with enough media spending, you're a lock. This created the ultimate growth industry, money feeder organizations like political action committees. Special interests took advantage of the new system the media created. If it took money to get elected, these groups now were given an opportunity to buy politicians to suit their purposes.

And so the media created this perverse money-driven democracy. In the beginning the money given to politicians by these special interest groups was small and the expectations fro politicians were low. "Due consideration" for their interests were all they could expect and was all they asked.

As the price tag for campaigns continue to grow, however, these groups had to give more. The more they gave, the more their expectations grew. Somewhere along the way, a line was crossed. That line is outright corruption, and today we're at a place where we have the worst government money can buy.

That was when we started seeing government turn a blind eye to good government. Take anti-trust. The goal of those regulations is to increase competition. One of the first examples was breaking Standard Oil. Two of the "sisters" were what we came to know as Mobil and Exxon. Guess what? These two companies were allowed to merge again, as were Conoco and Phillips. At the time, not too many people were upset, but that was the thin edge of the wedge. Economic history makes it very clear: each and every circumstance of competition killing merger hurts the economy. Jobs are lost, prices rise and economic power becomes concentrated. Anyone who tells us those oil companies didn't shovel money to politicians to get them to turn a blind eye to the laws they were supposed to uphold is either dishonest or naive beyond belief.

Other companies and industries took note. The rules have changed. We call it "deregulation" and we do anything we want, as long as we pay off the right politicos.

Back to the article (sorry this comment is so long). Some regulations, as noted above, were aimed at protecting us and the economy. Glass-Steagall has become perhaps the most obvious example, but it's not the only one. When those got swept away by corrupt executives and politicians, that hurt us. They used the good name deregulation had acquired from the AT&T and airline examples, but what they did was the exact opposite - they removed the protections we had from greedy businessmen who wanted to increase their market power at our expense.

Those are the cases where re-regulation is very much needed. Given how corrupt our political system has become, I very much doubt we'll get it. But hopefully I've been able to spell out two things:

Deregulation (and therefore re-regulation) means different things to different industries.

Regulation in some cases, banks in particular, was a good thing and worked extremely well for several decades. Their repeal has cost us dearly. Their return can only improve things.

Apr 16 02:50 PM

[JK Corcoran:]

Entire industries are made or broken by regulation and the Law of Unintended Consequences. Look at the CRA Act as instituted by Carter and "enhanced" by Clinton, Frank and Dodd. We ended up with regulation forcing banks, Fannie and Freddie to grow the CRA portfolio to 50%. Clinton made specific threat of sanctions to the banks that complained. This increase of loans to people who could not afford to pay them back according to normal underwriting (the very definition of CRA) was to achieve the goal of every American becoming a home owner. Nice sentimwent. The unintended consequence was that the mortgage industry now had a product they could give to anyone without risk as Freddie and Fannie were buying them up to come into compliance with the new regulatory standard. This triggered Wall Street to bring in a new ,very profitable product securitizing the mortgages, then selling them for great premiums as guaranteed (first tranche) by psuedo government agencies. Second and third tranches followed. The crash took Barney Frank from the forefront of getting every American a house to pillorying the very banks he and Clinton were threatening in order to make their initial plan work. So, yes, there was a lot of greed that contributed to this crash, but the opportunity was opened by our very politicians who are now scrambling for a fix.

Apr 17 12:28 PM

[PainfullyAware:]

Without Enforcement, No Regulation Can Be Of Benefit.

Complexity Favors The Sinister.

Special Case Legislation Is Discrimination And Skews Outcome. Too Much Has Become "The Playground Of Shysters" That Bend The Meaning Of Overly Complex Regulation To Gain Advantage.

What Happened To "All Are Created Equal"?

I Would Advocate - NO OFF BOOK ACCOUNTING OF ASSETS AND SHUT DOWN THE AVENUES FOR THE FICTITIOUS SHELL GAME AND FRAUDULENT VALUATIONS !!!

Apr 17 01:04 PM