Wednesday, June 17, 2009

Why regulation fails

An article reported by AP June 17, 2009 says in part:

Obama's sweeping change of business regulation also embraces new powers for the Federal Reserve and new rules that would reach into currently unregulated regions of the financial markets. An 85-page draft details an effort to change a regime that Obama's economic team maintained had become too porous for the innovations and intricacies of the today's financial markets.

This of course is not the first attempt to close up loopholes in the regulatory structure. Sarbanes-Oxley was supposed to improve reporting on corporate governance and prevent disasters like Enron and MCC. Before that many other regulations were published to deal with other loopholes.

But people are resourceful. Whenever a strategy that makes money for its practitioners is prohibited by regulation, people put their lawyers to work to find workarounds, or entirely new strategies. Over time the regulatory structure begins to look like Swiss cheese, because it’s impossible to anticipate and evaluate every strategy an innovative investor or his lawyer will devise. Some of the strategies of course are perfectly reasonable and perhaps even benefit society. Legislators and regulators don’t always make that distinction.

So what’s the solution? I argue for minimal government regulation and lots of transparency in the conduct of business affairs. The transparency ought not to be achieved by government regulation however, or we will end up with another expensive nightmare like Sarbanes Oxley. Transparency can be best assured by the most basic of laws, trade associations, and customer due diligence. With less regulation customers will realize enough additional profit to more than make up for the occasional shyster that slips past law, trade association policies, the Better Business Bureau and customer due diligence.

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