Friday, October 03, 2008

Reader Request: Government Regulation

Here is a question from my brother and Bottlenecked reader, Brad Jones:

What are the benefits of government regulating the market? Or why is everyone so pro-regulation? Any good reasons?

I believe regulation does and will always hamper economic growth. The free market allocates resources to their highest valued use and any government intervention with distort that process. That said, I believe there is a place for it. The only time that I support government regulation is when public money tied to that industry. For example, the FDIC's main roll is to be the lender of last resort to depositors. This means that no matter what happens to my bank my money is guaranteed, up to $100,000, by the federal government (although the new bailout plan could increase this). The purpose of this is to stop runs on the bank in times of panic (like in the Great Depression). Government regulation of the banking system makes sense because these banks have access to the public purse. If they fail, the taxpayers are partially responsible. As I've said before on the bailout of Freddie Mac and Fannie Mae, you cannot privatize the profits and socialize the risk. Daniel Mitchell of the Cato Institute says it like this: "Capitalism without loses is like religion without hell."

Let me state the obvious for a second. Despite all the problems the credit industry is having right now, we are much better off for having complex lending system we have today. Our system allows you to save for emergencies, for your next house, or for your small business. It then takes that those savings and turns them into loans for other people's emergencies, for their next house, or for their small business.

However, just because there is government funds in an industry doesn't mean regulation is the solution. It shouldn't come as a surprise that government officials usually think the answer is more government. The first option should always be to remove the government funds. This is the question I always ask when government intervention is proposed: Why would the market not take care of this problem alone? It may not always have a "fair" result, but it almost always has the best possible result. As my wife said last night responding to calls for fairness from the VP candidates: "this isn't Mario Kart, you can't get all red shells when you're behind."

As always, I enjoy answering reader requests, so feel free to contact me with your own.


  1. Brad Jones7:28 PM

    I'm still trying to get my mind around this bailout plan. Your question is "Why would the market not take care of this problem alone?" Great question. How would the market respond without government intervention? Could banks with lots of foreclosed properties survive? What if I have a mortgage with one of these overextended banks (and there was no bailout)? And I've not heard anyone really explain what will happen in response to the bailout solution. How is this going to help, specifically? Buying assets that the market doesn't want and distorting their true value seems bad... ? I saw some of Warren Buffet's interview and he said we need to get credit flowing again. What do you think?

  2. Your not the only person taken back by the complexity of this issue. But I have tried to gather some resources that may help (they can all be seen under my bookmarks section).

    In the beginning the was big government, and I said that was not good:

    A significant cause of the problem:

    Economists seem to agree, we should recapitalize troubled banks (which to my understanding means have them file a speedy Chapter 11 bankruptcy or possibly by buying them out at a really low, but probably correct price kind of like Buffett did for Goldman Sachs):

    Here is how expensive this is in items we can understand:

    Some more on it: "solving bad government with more government"

    Here is some more on why the bailout is bad and recapitalization is good. Here is the heart of the argument:
    "They earned great returns on the way up in return for bearing this risk; now they get to bear the risk." And I would add: Even if that means a recession for the rest of America. I'm willing to suffer a little in the short run so my children can enjoy the spoils of capitalism in the future.

  3. So to answer some of your questions directly:

    "Could banks with lots of foreclosed properties survive?"

    Probably not, but that is probably not a bad thing right. Bad business should go out of business. The role the government could take is to expedite their bankruptcies and restore trust between the better banks

    "What if I have a mortgage with one of these overextended banks (and there was no bailout)?"

    Well I can't imagine it would directly affect you (as long as you don't have an adjustable rate mortgage, which if you do you should definitely be fixing that mess). What would happen if your bank failed (or was bought out in the case of my bank Wachovia) is that your debt would just be sold to someone else.

    "And I've not heard anyone really explain what will happen in response to the bailout solution."

    I think the hope is to restore interbank "confidence." It's important for banks to be able to loan each other money (especially short term loans) and right now no one is sure who's a bad borrower and who's trustworthy. Which is why we need to hurry up and let these bad banks fail. But this has never really been done, so there's no guarantee this is going to work. And it is fairly certain we will never see a lot of that money again.

    "Buying assets that the market doesn't want and distorting their true value seems bad... ?"

    Supporting bad business is not good. This is my biggest fear:

    "The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years."

    "I saw some of Warren Buffet's interview and he said we need to get credit flowing again. What do you think?"

    I agree. But there many ways to do that, some worse than others.

  4. Schmidt7:29 PM

    You accidentally added some clarity to my taste in video games. No wonder I'm not as big on Mario Kart as all my friends!

  5. Ha, ha, good to hear Chris.

  6. Cheryl7:29 PM

    Dude!! You never really answered why people would be pro-regulations. I know in economic-land regulations are evil because they kill the capitalistic spirit. For the real world, I say, in moderation, they can and do infuse common sense and human decency into the system.

    Ever read Upton Sinclair's "The Jungle"?
    Hearing about the way the free-market of the meat packing industry ran prior to government regulation is insane and disgusting. How about child-labor laws? Without government regulations, I wouldn't trust companies to be forthright in where they get their labor. Nike anyone? Did people stop buying shoes when they heard Nike used child-labor overseas, thus allowing the almighty free market to solve our moral dilemma? Not really. Everyone just complained "then why are the shoes still so expensive?" Classy.

    At least ideally, regulations protect our laborers (ex: minimum wage, illegal immigrant worker issues), our environment (ex: limiting carbon emissions), our financial system (ex: limiting wall st. practices...oh wait), our media (ex: diverse media ownership rules allowing for competition... oh wait), and in general, protect individuals from the greed of system as a whole.

    Regulations aren't perfect. Government/the system/the man can get greedy or overzealous in the implementation of the regulations themselves. But there's no need to hate on regulations entirely.

    So to provide a simplified answer to the original question - the government took away rules and limitations on the ways the financial industry could invest, spend, or throw around money. And invest (in poor commodities), spend (like there's no tomorrow), and throw around (weee!!!!) our money, the financial industry did. And here we, the taxpayers, are today. So THAT is why SOME people would like to re-regulate.

  7. Thanks for the comment Cheryl, let me see if I can clear up my thoughts.

    "I know in economic-land regulations are evil"

    For one, if econo-land and the real world aren't the same thing, then we shouldn't be listening to economists. Hopefully all theorists are trying their bests to explain the real world. Second, I don't think regulations are bad per se. Like I said regulations are necessary if you are going to back the business with public money. My proposal is to get the public money out along with the regulations.

    "Hearing about the way the free-market of the meat packing industry ran prior to government regulation is insane and disgusting."

    I have no problem with the press exposing what goes on in the back rooms of businesses. However, the socialist author didn't want to inform the people only, he also wanted to implement laws. Why not just post the information (like the A,B,C rating on restaurant doors) and let the customers decide. The raised standards will of course raise the prices, and you can just let people decide how much they value food sanitation.

    As for child labor, I think that is a more complicated issue than you suggest. For one, many child laborers (legal or illegal) work to eat. It wasn't but a couple hundred years ago that child labor was the norm (now that doesn't mean it's ok, it just puts t things in perspective). Also, child labor laws actually depress the wages of child laborers (which is the intent). But that means kids who have to work to eat have to work more. Finally, increases in wealth not labor laws get rid of child labor. Before the US passed their laws, child labor was already steadily declining. And by imposing these laws, we could actually be delaying the time it takes to get to that wealth point. But like I said, this is a complicated issue.

    "At least ideally, regulations protect our laborers"

    The minimum wage, strict immigration laws, and similar laws do not protect laborers, but actually limit their choices. There is no doubt that forcing Company X to pay their workers an increased wage decreases the amount of people they can hire. Immigration laws limit businesses from hiring poor (relative to American poor) workers.

    Carbon limits and other environmental issues are a little different. That is more of an issue with property rights. Lakes get polluted because no one owns them. Assign property rights and let the courts take care of it (although they won't have to be the law suit will be deterrent enough).

    Financial regulations are again something different. That is the kind of regulation that I tried to focus on when I answered Brad's question (because that is why he asked it). These are issues of privatized profits and socialized risk.

    Let me restate, I don't hate regulations. But I think for the most part they are unneeded. I support property rights and laws that protect them, but I don't support many regulations. It is that power to regulate that makes the government such a good source for lobbying. Take the power out of government and money and politics won't be so tied together.

    Yes the deregulation of the financial market of the last 10 years was bad. And I think we would be better off if that deregulation didn't happen. BUT, we would be BEST off if we would have totally taken the government's fingers out of the mortgage industry.


You are the reason why I do not write privately. I would love to hear your thoughts, whether you agree or not.