Thinking about Business Regulation

The current financial crisis has been cast as a failure of the left by the right, and failure of the right by the left. Did laissez faire capitalism fail or was it excessive taxation or regulation? Perhaps it was a combination.

I use “left” and “right” here strictly in the context of capitalism, with “right” being those who espouse a maximally laissez-faire position, and left being those who favor government intervention. My own position is moderate in that I am willing to look at all points on that spectrum, but I lean strongly to the right in terms of solutions. I favor the economic solution that most depends on the general will of the participants in the economic system expressed in the way the spend their money, not in the way they vote at the ballot box.

I should note here for honesty’s sake, as well as to irritate those who can be irritated, that I see neither capitalism nor democracy as absolutes in and of themselves. They are both strategies used to accomplish something in particular. This means that I oppose socialism (in the sense of government ownership of the means of production, not in terms of progressive models of taxation), not because I think the idea of government ownership is morally bad in the first place, but rather because I believe socialism works poorly in appropriately distributing economic goods.

Similarly, I see democracy as one tool in helping to prevent tyranny, but I don’t think it is all that effective by itself. I would have no problem with various means of limiting or redistributing voting rights, provided those are evenly and objectively implied. The U. S. electoral college and the senate are both violations of pure one-person-one-vote policy, and I support both. I also don’t have any objection to literacy tests or to property requirements for voting, except that they have rarely been applied with an even hand, and I think human nature suggests they are unlikely to be.

Having thus thrown out a couple of inflammatory ideas not really related to my topic, let me proceed! My assumptions here, which I am not going to support in detail is that fraud prevention and infrastructure building are legitimate functions of government. Further I’m not an ideologue who holds a priori that government can’t do a certain thing. If an activity of government truly benefits its citizens, including not producing unacceptable side-effects, I wll accept it. In practice I generally believe that limiting government action to carefully circumscribed zones is better.

I think there is an important distinction that needs to be made as we think about government regulation or supervision of market activities. Process is important, and the principles that underly our action are also critical. The temptation, to which legislators almost always yield, is to write a law that prescribes results. In presenting such a law to the public, it is the results that are emphasized. You don’t generally see bills titles something like – “A Bill to Hire 10,000 New Regulators and Cause them to Swarm over the Banking System.” No, the title will be more like – “A Bill to Ensure Honesty in Banking” or something similar. (Examples are intentionally very generic.)

In the financial markets, we tend to get regulators looking to see to particular results, such as particular rations of assets to liabilities, certain levels of stability, guarantees of funds for depositors, and so forth. Not all of these goals are bad.

An alternative is to look at regulation from the point of view of the honesty and transparency of the process itself. In other words, rather than making sure that a bank cannot cross a particular line, aim at making certain that the public will know when the line is crossed, and focus enforcement on going after those who misrepresent.

Extreme capitalists may object to the additional regulation, but see no similar problem in, for example, requiring that someone who manufactures toasters is actually delivering toasters. If such a company instead delivers clever plastic models of toasters that do not do any toasting, that is fraud.

Similarly I should be able to walk up to a building with the word “bank” on the sign, and assume that I am dealing with something recognizable as a bank, rather than say a junk security marketing service or something similar. It’s simple to tell whether the toaster company is delivering toasters. It’s much more difficult to determine whether the bank is what I would traditionally regard as a bank.

When deregulation came along, this is an issue that I think was not adequately addressed. Banks were restricted from doing certain activities that were generally viewed as risky. Deregulation permitted such activities. So in effect we changed the definition of “bank” as applied to a business name from one thing to another. This deregulation was viewed as more capitalism. I would suggest that in some cases it was simply an abdication of the very proper role of capitalist government in preventing fraud.

I think there are many regulations that might be explained in either way–as a prescription of results, or as preventing misrepresentation. But I would be much happier if, as we consider how to keep markets more stable, we tried to emphasize providing investors with accurate information (including such infinitesimally small investors as myself) over simply preventing them from taken risks that they intelligently choose.

As a final note just to annoy a few more people if possible, I question the function of the stock market as it is constituted. I have no idea how one would change it, but right now it seems to me to be falsely labeled. It should be called the Stock Casino. I have no objection to legalized gambling, but I’d like gambling to be called gambling, and investing to be called investing. Unfortunately, there is a certain amount of gambling in investing, and there can even be investing in gambling. But could we try to draw a line?

OK, in the near future I will return to subjects on which I have greater expertise. I promise!