The Trouble With Regulation

For months now, people have been glorying in the supposed failure of the free market and how lack of regulation got us into our current dire predicament. However, let’s not be too hasty. Regulation is imperfect and can often cause more problems than it prevents.

What we have here is a failure to regulate?
Everybody’s howling about free market policies bringing us to this, but they’re ignoring the argument that Federal Reserve policy is very much at fault. There’s nothing purely “free market” about the Fed’s tinkering with monetary policy.

The Fed under Alan Greenspan created a massive bubble. Basically, we experienced way too much “boom” and the idea that we could constantly borrow our way to “growth.” Now we’re busting. Of course, the boom was darn good for companies that focused on things people want more than need. The bust is making things tough all over except for bargain companies like McDonald’s (NYSE: MCD  ) and Wal-Mart (NYSE: WMT  ) .

Many argue that some regulations directly fed into the crisis, such as the Community Reinvestment Act and its impact on how Fannie Mae (NYSE: FNM  ) proceeded, as well as its impact on banks’ lending practices. I’ve also seen it pointed out that the savings and loan crisis happened despite the fact that it was one of the most regulated industries around.

Regulators vs. reality
Meanwhile, I’ll bet we can all think of examples when regulators have done things that simply didn’t seem to make sense. How about the Federal Trade Commission’s bizarre and ongoing witch hunt against Whole Foods Market (Nasdaq: WFMI  ) ? Whole Foods’ CEO John Mackey contended that the FTC asked for more documentation from his company when it was trying to acquire Wild Oats than it demanded when ExxonMobil (Nasdaq: XOM  ) hooked up. Meanwhile, the whole thing was absurd, since Whole Foods faces competition from everybody from Wal-Mart to Trader Joe’s.

It probably seemed clear to most of us that Sirius XM (Nasdaq: SIRI  ) was struggling under the weight of competition from many fronts, but the Federal Communications Commission took its sweet time (a year and a half) giving the OK for their merger. There’s an argument that that delay contributed to Sirius XM’s particularly dire predicament now.

The Securities and Exchange Commission could be seen as a poignant symbol of failure; it was founded after the Great Depression specifically to protect investors. In October, it was arguable that the SEC had let us all down in many ways, including allegations that it had been seeking enforcement against small violators rather than tackling large ones. More recently, the agency’s failure to uncover the alleged Madoff Ponzi scheme should make our blood run cold, especially since some even tried to alert the agency that something was amiss.

So shouldn’t we be extremely leery of increasing regulation, especially when short-sighted, slow, perhaps incompetent, possibly even corrupt regulators don’t seem to be in short supply? I’ve often been disturbed at how often high-profile figures from the government and corporate worlds bounce back and forth. It’s easy to see how conflicts of interest may arise in that environment among temptations to influence rulemaking for buddies in the industry.

For example, let’s admit it was a little creepy that former Treasury Secretary Hank Paulson’s career included time at Goldman Sachs (NYSE: GS  ) . I recently ran across a Portfolio article delving into conspiracy theories. Some posit that Lehman failed while others were bailed because Lehman wasn’t as well connected in government. That may be a crazy conspiracy theory or sour grapes, but then again, let’s not forget the old saying that just because someone’s paranoid doesn’t mean all their supposed delusions aren’t true.  

No angels here
In the Federalist Papers, James Madison said, “If men were angels, no government would be necessary.” That quote always makes me think the same philosophical issue applies to people in government. (Madison’s quote goes on to say the government must be obliged to control itself, which may be easier said than done.)

I believe we should take a few deep breaths before adhering too strongly to the idea that more regulation is the obvious solution and panacea for all that ails us, and that regulators would have been able to head off all the dangers or even adequately foresee them at all.

Meanwhile, when it comes to regulation, the possibility of corruption and the same self-interest blamed in free market failure is very high, lobbying always causes problems, and, let’s not forget unforeseen circumstances. Even now, forming more and more “too big to fail” entities after our recent bailout frenzy may end up being a perfect example of how government can make some pretty massive strategic mistakes.   

Maybe instead of beating up on free market ideology and viewing regulation as salvation, we should contemplate what has really failed miserably: people’s ethics. Greed, ignorance, and short-term thinking have run amok, and it seems many people forgot how important it is to be responsible for their choices and to simply think with a reasonable, long-term view.

I fear that until people begin to expect a bit more of themselves and others, we will face many, many devastating failures, regardless of whether we adhere to free market or pro-regulation ideologies. And no matter what we see fit to blame it on, we won’t be able to bail ourselves out.

Wal-Mart Stores is a Motley Fool Inside Value recommendation. Whole Foods Market is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. The Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (15)

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  • Report this Comment On February 17, 2009, at 4:36 PM, emferguson wrote:

    I have to strongly disagree with this paragraph: "Many argue that some regulations directly fed into the crisis, such as the Community Reinvestment Act and its impact on how Fannie Mae (NYSE: FNM) proceeded, as well as its impact on banks’ lending practices. I’ve also seen it pointed out that the savings and loan crisis happened despite the fact that it was one of the most regulated industries around."

    The savings and loan crisis happened after and as a result of deregulation, not despite strong regulation. The Community Reinvestment Act prohibited the lending practices that caused the subprime mortgage crisis. It was hollowed out by deregulation. Fannie and Freddie were very late to the game in terms of the mortgage bubble, getting at the end, which doesn't absolve them of that bad decision, but they're hardly to blame for the problem. I would concede that they should have remained government entities and never been privatized.

  • Report this Comment On February 17, 2009, at 5:39 PM, Atrossity wrote:

    Thank you for writing this excellent article. I agree wholeheartedly that regulators have to be people you can trust to be neutral and fair and believe that our regulatory infrastructure is structurally unstable and merely adding more rules and staff will only strengthen a system that is fundamentally flawed. I do believe that deregulation and borderline or not so borderline corruption in regulation put us where we are today but feel the answer is first most and foremost to undertake a thorough housecleaning and build a new structure that makes the regulators very aware that they need to be clean and accountable or suffer severe consequences. We as a nation can’t afford to have the best regulators money can buy. Thanks again Ms. Lomax.

  • Report this Comment On February 17, 2009, at 6:24 PM, AlyceFan wrote:

    Alyce, much of what you say here is true. And as usual you make a clear and cogent argument.

    There is certainly a segment of the population that is as you say "glorying in the supposed failure of the free market." However, in my view that segment is quite small (though possibly more vocal than others)...and there is an equally loud segment that proclaims nearly all regulation is injurious that are equally loud. Curiously that latter group (excluding perhaps true Libertarians) often has no problem with regulating our personal lives. In any case, the vast majority are somewhere in between.

    Other than the aforementioned libertarians and those living on either fringe, most people would accept that some level of govrnment intervention in the economy is warranted. And debates over the appropriate level of this regulation has been going on since the founding of the republic.

    Alexander Hamilton is often revered by modern conservatives as the father of American capitalism. Yet it was Hamilton who proposed the first large government intervention in the economic life of the nation - over the intense objection of both Thomas Jefferson and James Madison. In particular his scheme to have the federal government assume the revolutionary war debt ofthe 13 states was considered by them as a power grab by northern politicians and their monied backers.

    Thomas Jefferson, revered by some today as the first champion of a limited government presided over the single largest expansion of federal power in the early republic with the Louisiana purchase.

    James Madison who you quote above, embodies this early struggle with the role of the federal government in the economy. This quote from Fedralist 51 was made at a time when Madison was a very strong proponent of a powerful central government. Later, he became an ally with Jefferson in opposition to a strong central government,often expressing views that were at odds with those he held while arguing in favor of the new constitution. Yet even at this time his support of an embargo of British goods led him to propose that coastal states carry out punitive embargoes and blockades against interior states who refused to obey restrictions on trade.

    These debates have continued throughout our history. Andrew Jackson vs. the Second Bank of the US, Abraham Lincoln's efforts to fund the Civil War, formation of the federal reserve in the early 20th century, the New Deal, Square Deal, Great Society and Reagan's efforts were all about debating the appropriate level of federal intervention in the economy - not whether it should be eliminated completely or applied across the board.

    You are absolutely right that there are saints and sinners in both the private sector and in government (Bernie Madoff anyone?) However, only the government is truly accountable to the people. There is very little the average person can do to control the greed and corruption in the corporate world other than to look to the government (at whatever level) for redress. When that greed and corruption is not hurting the economy at a macro level prosecutions are probably enough. However when that greed and corruption runs amok to the point where it is taking down the country, greater regulation is absolutely warranted.

    Not that this is a panacea, and frankly I don't know anyone in a position of responsibility who claims that it is. But it is necessary step in my view, toward reclaiming the appropriate balance between allowing free markets to operate and making sure the public is protected from those who could care less about the economic health of the country so as long as they are enriched.

  • Report this Comment On February 17, 2009, at 9:50 PM, mlaursen wrote:

    re: "There is very little the average person can do to control the greed and corruption in the corporate world other than to look to the government (at whatever level) for redress."

    Sometimes true, althought the average person can oten take their business elsewhere.

    There is very little the average person can do to control greed and corruption in a huge, remote Federal government. Your vote exercises a miniscule bit of power over what the government does, yet the government has been grown to have power over just about every aspect of the lives of every voter. The balance of power is way out of kilter.

  • Report this Comment On February 17, 2009, at 11:24 PM, AlyceFan wrote:

    I don't know...moving your business elsewhere often means just patronizing another part of the same conglomerate.

    When is the last time any kind of organized consumer action actually had an affect on a large corporation?

    However an electorate moved to action can have a significant affect on the governance of the country. There are many examples of this through history.

    While it is true that the government has many flaws, overreaching in many areas, perhaps underreaching in others (regulation and inspection of food plants for example), by and large its size reflects what the electorate expects of it, no matter how fashionable it is to complain about it.

  • Report this Comment On February 17, 2009, at 11:34 PM, HBinswanger wrote:

    Yes, the crisis marks the failure of "the regulatory state." Banking and insurance have been minutely, agonizingly regulated since the New Deal.

    Regulations can't substitute for the free mind. Bring us back (or forward) to laissez-faire capitalism.

  • Report this Comment On February 18, 2009, at 8:43 AM, AlyceFan wrote:

    "Bring us back (or forward) to laissez-faire capitalism."

    Yeah...bring back the gilded age..gotta love those robber barons...probably the closest the US has ever come to a laissez-faire economy...

    good time :)

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