Wednesday, April 21, 2010

A libertarian view of financial regulation

In The Wall Street Journal, Gerald P. O'Driscoll writes:
Public choice theory has identified the root causes of regulatory failure as the capture of regulators by the industry being regulated. Regulatory agencies begin to identify with the interests of the regulated rather than the public they are charged to protect. ...

Congressional committees overseeing industries succumb to the allure of campaign contributions, the solicitations of industry lobbyists, and the siren song of experts whose livelihood is beholden to the industry. The interests of industry and government become intertwined and it is regulation that binds those interests together. Business succeeds by getting along with politicians and regulators. And vice-versa through the revolving door.

We call that system not the free-market, but crony capitalism. It owes more to Benito Mussolini than to Adam Smith.
His point is correct and well-documented, but I get a chuckle out of the fact that the author appears to be an example of what he criticizes. According to his short bio, he "has been a vice president at Citigroup and a vice president at the Federal Reserve Bank of Dallas."

Regarding housing he writes:
In the U.S today, we are moving away from reliance on honest pricing. The federal government controls 90% of housing finance. Policies to encourage home ownership remain on the books, and more have been added. Fed policies of low interest rates result in capital being misallocated across time. Low interest rates particularly impact housing because a home is a pre-eminent long-lived asset whose value is enhanced by low interest rates.

Distorted prices and interest rates no longer serve as accurate indicators of the relative importance of goods. Crony capitalism ensures the special access of protected firms and industries to capital. Businesses that stumble in the process of doing what is politically favored are bailed out. That leads to moral hazard and more bailouts in the future. And those losing money may be enabled to hide it by accounting chicanery.
For the record, I don't agree with the author's conclusion in the final paragraph of the WSJ article. The author opposes government regulation. I favor regulation, but believe it should be based primarily on proactive and consistent automatic rules, rather than reactive and fickle human judgment.


  1. James, I think what you're getting at is Hayek's distinction between an economy in which there is planning FOR competition and an economy in which planning REPLACES competition.

    If I understand Hayek correctly, he believes that the libertarian obsession with absolute lassiez faire is a product of the need to distill liberal (in the classical sense) economic principles into a punchline.

    There is nothing inconsistent with free market competition and regulation of the markets, as long as the regulation is consistent, predictable, and calculated to enhance the beneficial effects of competition. Hence the distinction between the rule of law (financial regulations laid out in advance and applied across the board) and an oligarchy of central planners who made post-hoc human judgements regarding what to do in the wake of a crisis.

    I submit that having a robust and properly enforced SYSTEM of regulations will reduce the temptation to empower human regulators with the task of making case-by-case judgements that, in effect, amount to a central planning of the economy by alleviating "competitors" of the consequences of their actions.

  2. A central banker with a goal of controlling all the world's banks through a central world treasury (this is very actively being discussed in foreign economic news) will, of course, poo poo the existing system. This is the typical Hegelian argument -- intentionally create a problem, and then propose a solution to "fix" the created problem, in order to lead the masses to your preconceived goal.

    Central bankers are wealthy enough to get a better education than most people in the world, which is why most people will fall for this agenda and as Kissinger has stated in the past, the people will welcome the New World Order with open arms, asking for it to replace the existing system.

    Such is life. All we peons really need to care about is how to protect our wealth so it doesn't get taken away from us due to some crappy carbon credit tax.

  3. Yes, he seems to be an example of what he criticizes but this is what we should expect. Those who have captured power and profit in the past will complain about the system when they are thrown out by another group. The people don't really see any change, "Meet the new boss, same as the old boss".

    I think the reason many Americans see government as ineffective is this recurring process of the capture of regulatory power and then, when the regulator fails to act, the extension of government, not buy fixing the existing system, but by adding additional, inefficient layers to the system. They don't see how this new layer of government will help, and rightfully so, if the first regulator was captured it's only a matter of time before the new one is rendered ineffective. The end result is an ineffective government-corporate system that spawns a new crisis every few years. The Democrats cry for more regulation, the Republicans scream that regulation doesn’t work and the whole crappy process continues.

    What is needed is true government reform on a regular basis, a government operating as a business, not a bloated corporation like GM but a hungry, nimble, efficient business. One that reviews itself on a regular basis and adapts as required.

    In this most recent case, the SEC (or FED, or someone) didn't do their job. Now is the time to act to build consolidated, efficient and responsible regulator. So we should

    - Fire the current management and give the job to people who can handle it.
    - Fire dead-beat staff to inspire the remaining staff.
    - Review and fix the law so it works.
    - Give the new management the power and money to enforce the law.
    - Tell the new management that if they don't do the job they'll be fired (or maybe shot).
    - Close the smaller competing regulators and give their jobs to the SEC.
    - Again, hold everyone responsible.
    - Repeat every few years.

    This is the kind of “Change” I was looking for when I voted Democrat for the first time in my life.