Regulation Is Good for America

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Over the last 80 years, we've been led to believe that governmental regulation of the economy is bad for society. Politicians say it's a slippery slope to socialism. Economists argue that it impedes the efficient allocation of resources. And the financial elite claim that it stymies their incentive to excel.

These feelings manifested themselves recently in the Jumpstart Our Business Startups Act, or JOBS Act, which President Obama signed into law at the beginning of this month. In short, this piece of legislation effects a sweeping overhaul of the initial public offering process and exempts wide swaths of securities from the watchful eyes of the Securities and Exchange Commission.

But what if I were to tell you that this entire thesis is flawed? That governmental oversight of the economy isn't bad for the vast majority of investors? And that our regulatory framework is in fact more responsible for our global economic hegemony than any other discrete and identifiable group of modern policies?

Would you believe me? I doubt you would, even though it's demonstrably true.

The birth of securities regulation in America
The securities laws as we know them sprung from the Great Depression.

At the time of their creation, bank failures numbered in the thousands, one in four families had lost their life savings, unemployment was 25%, industrial production had been cut in half, signs of malnutrition among schoolchildren were increasingly evident, and the Hoover administration had even ordered the violent dispersal of World War I veterans from the National Mall for demanding early payment of a promised bonus for wartime service.

With this as the backdrop at the beginning of 1933, a little-known prosecutor named Ferdinand Pecora succeeded at eliciting admissions from the nation's richest and most powerful bankers that they had knowingly defrauded the country's burgeoning middle class and systematically manipulated the stock market.

To cite a prominent example, Charles Mitchell, the president of National City Bank, the predecessor of Citigroup (NYSE: C  ) and the largest bank in America at the time, testified before Congress that the lender's affiliated investment bank, National City Company, had funded stock pools to inflate the value of specific stock prices, concealed the losses of its parent company, bribed foreign officials, and literally bankrupted unsuspecting investors by selling them unsound securities derived from bad loans to Latin American countries. "Mitchell more than any 50 men is responsible for [the] stock crash," said Senator Carter Glass.

It was in the midst of this reality, in turn, and notably not in the sterilized world of classical economics textbooks, that our principal securities laws were born.

The first was the Banking Act of 1933, otherwise known as the Glass-Steagall Act, which established the Federal Deposit Insurance Corporation and severed the affiliation between commercial and investment banks. The second was the Securities Act of 1933, which required that newly issued securities be registered with the Securities and Exchange Commission unless otherwise excepted from doing so. And the third was the Securities Exchange Act of 1934, which formally established the SEC and regulated the trading of pre-existing securities and stock exchanges.

Regulation is needed now more than ever
In case you think the aforementioned behaviors are a thing of the past, which would ostensibly eliminate the need for continued governmental oversight, consider the role that the now-infamous multitrillion-dollar swaps market played in the recent economic crisis.

In 1998, Federal Reserve Chairman Alan Greenspan testified to Congress that proposed regulation of this market was "unnecessary" because "participants in financial futures markets are predominantly professionals that simply do not require the customer protections that may be needed by the general public."

Yet 10 years later, the failure of this very market convinced a Republican Treasury Secretary and former CEO of Goldman Sachs (NYSE: GS  ) -- anything but a rampant socialist -- to nationalize the world's largest insurance company, American International Group (NYSE: AIG  ) , and forcibly inject capital into the country's largest banks including Bank of America (NYSE: BAC  ) and JPMorgan Chase (NYSE: JPM  ) , among others.

To Greenspan's credit, of course, he subsequently admitted that his blind faith in the free market was misguided. In 2008, for instance, he told the House Committee on Oversight and Government Reform, "Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief." And he went on to state, albeit in his typically opaque manner, that he had "found a flaw" in the ideology that pushed him to resist regulation of the derivatives and subprime mortgage markets.

The persistence of a flawed ideology
In open defiance of history, proponents of deregulation nevertheless continue to pontificate upon the virtues of a completely unfettered market and the vices of governmental oversight. They argue that the latter stymies economic growth and aggravates unemployment, among other things.

As above, however, even a cursory glance at reality disproves this.

Consider the impact of a well-regulated market on the cost of capital in the United States relative to other countries around the world. My colleague Ilan Moscovitz recently dug up revealing statistics about this with respect to China, which is not insignificantly the second-largest economy in the world. According to Ilan, in the last year and a half alone, the cost of capital for small Chinese companies increased by a staggering 160%. And today, investors charge these companies five times as much for their equity as they charge their U.S. peers.

The reason for this is simple: Global investors trust regulated American capital markets more than their unregulated Chinese counterparts. And for good reason. Over the last few years, the financial news has been replete with stories of fraud emanating out of China.

Probably the best known of these was the case of the Chinese forestry company Sino-Forest Corp. In the middle of last year, shares in the company fell 72% in two days after the short-seller Muddy Waters questioned its accounting and whether it inflated the value of its forestry assets. Although the company denied the claims, an internal committee last month issued a report saying "there remain issues which have not been fully answered" about its business and relationships with land owners.

And the list of examples like this goes on. Fellow Fool Dan Newman identified no fewer than seven instances of recent potential fraud by different Chinese companies. And in a report cited by my colleague Alyce Lomax, GovernanceMetrics International noted that many Chinese companies listed in the United States have little to no intrinsic value, are thinly capitalized, and almost all have simply relied on the China brand to go public, much like unprofitable Internet companies did in the run-up to the tech bubble.

Ultimately, the benefits of deregulation are a myth
There's a commercial that airs on Bloomberg business channel for Citigroup. It has sweeping and majestic views of lower Manhattan, the Stock Exchange building draped with the American flag, and Citi's stately former headquarters at 55 Wall Street. Yet you never hear the narrator disclose the institution's central role in repeatedly crashing the economy and decimating the financial lives of thousands, if not millions, of Americans.

Well, it's this type of one-sided propaganda that's led us to believe in the virtues of deregulation. Is it good? Yeah, no doubt about it. But only for Wall Street's snake-oil salesmen who use it to effectively steal Main Street's hard-earned money. Thus, unless you fall into the former class, I recommend you revisit the premises underlying your faith in Wall Street's idea of a free market.

Fool contributor John Maxfield owns shares in Bank of America. The Motley Fool owns shares of Citigroup, Bank of America, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of The Goldman Sachs Group. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (31) | Recommend This Article (40)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 27, 2012, at 12:38 PM, greg0 wrote:

    Wow. An excellent article. I am amazed it was published on MF -- which usually publishes worthless drivel.

    Now if they remove the deceptive "The Steve Jobs Betrayal" (spoiler: Google stole Apple patented technology for Android), MF might not seem so ridiculous.

  • Report this Comment On April 27, 2012, at 2:47 PM, deckdawg wrote:

    The title of the article should be Good Regulation is Good for America. First of all, while politicians might say bad things about regulation, they all love it ... the more the better. Government regulation is, after all, the playground of special interest. Paying politicians to carefully craft regulations with subtle (and sometimes, not so subtle) little nuances that highly favor a particular special interest is how lobbyist spend their client's money. Obviously, we must have regulations, but to be good they must accomplish a purpose that is good for all, and be free of all the special carve outs. And, they must be evenly enforced. If government regulation were an automatic good, countries like India would be paradises on earth.

  • Report this Comment On April 27, 2012, at 3:08 PM, CluckChicken wrote:

    Most regulation comes about because something happened and a lot of people said "that is wrong and something should be done to stop that from happening."

    Anybody that tells me that an industry (any type) is capable of self regulation is either first, a future crook or second blind to history.

  • Report this Comment On April 27, 2012, at 3:53 PM, DJDynamicNC wrote:

    Outstanding article, and timely.

    Deckdawn, of course you're right, there can be bad regulations just as there can be good ones, but the author quite rightly is addressing the pervasive belief that regulations are always bad or, at best, a necessary evil, and should be trimmed at all times no matter what. You say "of course" we need good regulations, and you're right, but for all too many people that "of course" would be contested.

  • Report this Comment On April 27, 2012, at 4:19 PM, seattle1115 wrote:

    Excellent article. Prepare to get an earful from the usual suspects.

  • Report this Comment On April 27, 2012, at 4:49 PM, garifolle wrote:

    Yes regulation "would" be good for America.

    The financial lobbyists will make it so that it will- at best - only give an appearance of regulation.

    Please remove "The Steve Jobs Betrayal" and stop offering "free" reports that are totally outdated, and only a way of luring us into signing for junk mail.

    I think all your readers share my hate for those.

  • Report this Comment On April 27, 2012, at 5:17 PM, DJDynamicNC wrote:

    ^^ Easy enough to ignore (or, in the case of Steve Jobs, to simply Google the answer when curiousity struck).

    Somebody's gotta keep the lights on, and I'd rather let the advertisers subsidize the site than have to lock out new investors by requiring a membership fee or paywall.

  • Report this Comment On April 28, 2012, at 10:19 AM, wjcost wrote:

    Wow what a great article and really great comments. Thanks, all!

  • Report this Comment On April 28, 2012, at 12:41 PM, 1i22 wrote:

    Since the human species has never excelled in rationality or self-management, some sound, thoughtful regulation has always been necessary to protect us from ourselves and from our zeal toward productivity, profits, or other achievement orientation. And, as one might guess, we must be guarded from the results of plain old laziness. We need good rules and regulations and those who administer them. Let's use them to our mutual advantage. KW

  • Report this Comment On April 28, 2012, at 12:41 PM, DAG_Investments wrote:

    Excellent article indeed. I've now read two of the best articles I've ever seen on MF within a span of two days... what happened all the sudden!? By the way, the other was the article about Bernie Madoff.

  • Report this Comment On April 28, 2012, at 1:15 PM, Chontichajim wrote:

    Timely for me since I just finished reading 4 new IPO prospectives, one using the modified "Jobs Act". The rules they are excepted from make it sound so potentially ugly that I will not even give those IPOs consideration. They are allowed to not fully report Executive compensation, golden parachutes, or allow stockholder votes on compensation (which follows if you don't know it). I thought it was more of a tax break or Sarbanes/Oaxly breaks directed toward employment. I guess executives are employed, but that is not what I had in mind.

    At least we are light years ahead of China and miles ahead of Brazil. Lets stay there.

  • Report this Comment On April 28, 2012, at 3:37 PM, ynotc wrote:

    As new financial products, such as derivatives, are added we do need to articulate rules. But to say that older products need more rules is unsound.

    The old rules just need to be enforced. Read the book "No One Would Listen" about the Madoff scandal and you will find that the SEC was handed enough information to convict Madoff on 5 separate ocasions and did not act.

    Sometimes "new" rules on old products or industries actually create the problem such as when the Glass Steagal act was gutted. This made way for the current mess that we are still dealing with. If Glass Steagal was left in place banks would not have been allowed to sell financial products.

  • Report this Comment On April 28, 2012, at 4:27 PM, anathestalker wrote:

    Somebody show this article to RON PAUL's minions.

  • Report this Comment On April 28, 2012, at 5:34 PM, LoadDrive wrote:

    From the time that Obama Walking into office, till now, more “20,000 pages of new regulation’s has been added to the books “Of top of the other 100,000 of pages of regulations, that we don’t ever know “what they are. Now that oil production in the U.S. has been regulated to the point that Gas cost over $4.00 per gallon, companies are regulated to the point that unemployment is over 18% (Note: Go investigate the Other set of books, where people have stopped looking for jobs, YES…over 18%) And houses are selling for about 1/3 of what they were selling for 8 years ago, and your money is worth less; “Why YES, MORE Regulations has been Outstanding for our country!

  • Report this Comment On April 28, 2012, at 5:37 PM, lowmaple wrote:

    1i22 plain old laziness. I would argue that some of those lazy laws were well thought out and took months of work, but for the wrong reasons.

  • Report this Comment On April 29, 2012, at 1:02 PM, MrChapel wrote:

    As others have stated, regulations are the playground of special interest groups. Especially today, in this administration that calls itself 'the most transparant administration'.

    As a conservative, I'm all for well thought-out regulations and laws. However, we don't have those, do we? No, we have to 'pass it so we can read what's in it', as Pelosi said. We have to go through 3000 pages of lawyer-speak and double-talk, with another 1500 pages of amendments that have absolutely nothing to do with the actual law. We have lobbyists offering discounts on IPO stocks and horse-trading politicians adding pork for their own gain.

    I was pleasantly surprised by a number of the new House members who put forth clear, concise legislation on two pages maximum. Easily readable for those not with a degree in law. That is what we need more of. Short, to-the-point laws and regulations. No a million and one amendments for different scenarios so the law benefits those it's supposed to be curbing their darker impulses. Lobbying should be forbidden. No more favors traded like horses between politicians. No more amendments that have nothing to do with the actual subject. Also a sunset clause so that after five to ten years, the law/regulation expires and has to explicitly be renewed.

    And above all, bring back Glass-Steagal and throw out all the new regulations, executive orders and Czars the current admin has brought forth. Kick out all the cronies in DC that got their public jobs because they donated huge sums to the campaign.

  • Report this Comment On April 30, 2012, at 1:29 PM, whereaminow wrote:

    More propaganda from Motley Fool. Hilarious.

    Let's get this straight. America has more regulations, more regulatory agencies, more regulatory employees, and more money spent on regulation than ANY country has ever had at ANY time in human history.

    But it's not enough. We need MORE. More will solve the problem. It hasn't worked well enough, so the answer then.. . is MORE. More more more. More will solve all the problems!

    Well if your audience is illiterate twelve year olds scarfing down Twinkies (allowed by regulation) while watching SWAT teams take down raw milk dispensers (not allowed by regulation) while Monsanto collects royalties from poisoning and trespassing on your neighbors farm (allowed by regulation) and your doctor is forced to see 50 patients in a day to comply with insurance mandates (thanks to regulation) as his competitor that sells physician care direct to the consumer is hounded by police (already not allowed by regulation under RomneyCare, and soon under ObamaCare)... and you think this is all just super cool... yay Freedom and Jersey Shore! America... Eff Yeah!!!!

    Or one could simply wonder, with the level of Fascism currently existing in America - and for those of you who suffered through public school, fascism is where the government and big business partner to run your lives at the expense of your liberty - how are you going to get people into government that will "take on the greedy corporations" and make all those super duper awesome regulations that are always so close to working but just never work?

    Tell me, how are you going to change government to get the "right regulations" passed? I want to hear your plan.

    In the meantime, I'm going back to eating grass fed beef, avoiding prescription drugs at all costs, saving my money in gold and silver, and not listening to idiots that think more regulations will make my life so super swell it's just the bestest ever!!!

    David in Liberty

  • Report this Comment On April 30, 2012, at 1:44 PM, Liberty4All wrote:

    Government regulations that are clear, concise, and force transparency into corners made dark in an industry's self-interest can be a boon to a capitalist economy. Some laws on the books may even fit this description.

    We tend not to get those, do we? Instead, we get vague, elastic language, open to interpretation, and that's where the lobbyists and the special interests walk in.

  • Report this Comment On April 30, 2012, at 2:04 PM, damilkman66 wrote:

    This is a terrible article. I have nothing against the author's opinions. I will admit I am for less regulation rather then more. However, there is no statistics given or any attempt to quantify regulation on the whole. I am sure there is good regulation. But there is also bad regulation. If regulation is good, why not there be an infinite amount of regulation?

    A better question would be what is the right amount of regulation and how do we quantify good regulation verses bad? There is no doubt that there are examples where regulation is needed. Yet there are probably many examples of regulation that were disasterous. So the author lists the good examples and we are supposed to conclude that generic regulation is always good? After all the United States was already the number one world power prior to any of the regulation that is cited.

    If there in no regulation, there is anarchy. I do not believe anyone wants that. The better question to ask is what should be the governments role in regulating activity?

    Since the author focuses on banking, I think one could make a resonable case that the lack of certain kinds of regulations distorted the securities, bonds, insurance, and derivatives markets. But then to lump in everything else is good including some of the insane stuff is ridiculous.

    So what the author should have done is made a qualification on what is good regulation. In this case it is preventing distortions and fraud. That would be a perfectly reasonable premise. Then someone like me could give examples where a government regulation distorted the market and point out how that kind of regulation is bad.

    In summary I am not against better regulations when the market has failed. I am willing to listen. But do not make a blanket statement that more regulation is better without defining what makes good regulation.

  • Report this Comment On April 30, 2012, at 2:34 PM, whereaminow wrote:

    I'm just curious, before I waste my time.

    Does anyone in this comment thread want to hear a counter story that disputes the cause of the stock market crash in 1929, the importance of Glass Stegall, the idea that Greenspan was a "free market guy", or that deregulation was in place for this latest crash?

    The author of this article had to throw in his little jibe about shaking our ideological faith, but does he really want you to hear our side of the story? I highly doubt it. In fact, many on this thread have heard and understood my position, and have never been able to counter a single point, yet they continue to have unshakable faith in their ideology.

    Statism is a religion. Which is sad, because the State is obselete.

    David in Liberty

  • Report this Comment On April 30, 2012, at 2:58 PM, atkinskd wrote:

    An idea I've been tossing around, in accordance with the idea that we need to enforce the ones we have, is to form a Redline Committee. Their sole purpose would be to revise and update statutes that are in need of such to operate in the manner desired. My experience has been that the Letter of the Law is in no way prepared to handle the intent of said law. Congress needs to become the nations 'Document Control' department as it were.

    Funny thing about China. A piece I read pointed out that derivatives trading there is punishable by death. They may be the 2nd largest Economy for now, but as Soros has pointed out repeeatedly, an economy can be toppled easily by simply betting on the losing horses and waiting for the bubbles to pop.

  • Report this Comment On April 30, 2012, at 3:00 PM, aptosjoe wrote:

    An excellent article and sorely needed but I doubt the mind set of those who need it the most will allow them to understand the author's point. Some regulation is in fact good and necessary.

  • Report this Comment On April 30, 2012, at 3:23 PM, XMFGortok wrote:

    The author ignores that the free money from the Federal Reserve (interest rates at near zero) are what fueled the distortion (err. bubble?) that came crashing down.

    So, the author blames the effect (the swaps being called) with the cause (the cheap money that distorted the investment process), and then proceeds to cheerlead for more things to deal with effects, instead of dealing with the cause: The Federal Reserve system.

  • Report this Comment On April 30, 2012, at 3:23 PM, mattysmitty wrote:

    Oh Canada!

  • Report this Comment On April 30, 2012, at 3:33 PM, hbofbyu wrote:

    We have immigration laws too but to no effect except where enforced. You can't legislate good behavior. America is only as good as the public virtue of the people no matter how many laws and regulations are passed. If they are not enforced we become Russia, China, India, or Chicago were a bribe or a payout gets you anything you need. (Is Chicago America?)

  • Report this Comment On April 30, 2012, at 4:19 PM, DividendsBoom wrote:

    Oh John, you make me laugh. Silly, silly John.

  • Report this Comment On May 01, 2012, at 5:08 AM, CaptainWidget wrote:

    I agree, regulation is great. As long as I'm the regulator.

  • Report this Comment On May 01, 2012, at 7:46 AM, The1MAGE wrote:

    Interesting thoughts on regulation.

    Very compelling.

    Then I look at the tax code. All 71,684 pages of it. (2010 numbers.)

  • Report this Comment On May 01, 2012, at 3:59 PM, jvgfool wrote:

    Democracy is a political system. Free market capitalism is an economic system. In a true democracy where the citizens govern, the political system manages the economic system.

  • Report this Comment On May 01, 2012, at 7:05 PM, whereaminow wrote:

    Tom Woods absolutely destroys juvenile nonsense like this here:

    David in Liberty

  • Report this Comment On May 02, 2012, at 4:01 AM, Eliz1000 wrote:

    Discarding all but the most important parts of laws, and simplifying, taking out all the loop holes which have been included for friends of congress would go a long way towards helping inforce the laws which are left. Why have bills that are 2000 pages long? Its olnly so that corporations and individuals can claim questionable tax exemptions. Think of the time and money spent on accounting and filling out government papers, which could be used for more productive purposes. WE NEED FOUR DAY WEEKS SO THAT WE HAVE TIME TO BE CONTRIBUTING MEMBERS OF OUR SOCIETY, AND HAVE QUALITY LIFE!

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