The Right Kind Of Regulation

Over the past few weeks, I've been writing a lot about financial regulation. It's one of the favorite topics these days among politicians and policy wonks in Washington. In my various writings, I've advocated several approaches to different sorts of regulation. I'm always a little shocked to see commenters who are angry at the regulatory measures I suggest. My surprise mostly stems from the fact that my views on regulation are pretty mild compared to others I've read in the blogosphere. I thought it might be helpful to explain what I view as the right and wrong kind of regulation.

Before getting into that, however, I would like to pose a question to those who do not believe in even minimal regulation for the financial industry: what, then, would you suggest? Do you believe that the financial industry functioned well in 2008-2009? If not, what's your view of what could have helped prevent the crisis once the bubble popped? I would be the first to agree that preemptive steps should have been taken to attempt to prevent a real estate bubble in the first place. But given human nature, it's pretty difficult to prevent bubbles. So shouldn't we attempt to construct an economy where when a bubble pops the financial system doesn't also collapse?

I believe such a market would be desirable. And that's not the market we have, as we learned last fall. That's why I believe some new regulation is desirable. In particular, I am for any regulation that strengthens capitalism. I am against any regulation that doesn't.

For example, I've written a great deal about the idea that the U.S. needs a non-bank resolution authority. I don't support such an authority because I believe the government needs to be more involved in the market. In fact, I detest the idea of increased government involvement in the market. But having such an authority in place actually benefits capitalism. It would allow firms who have made poor decisions to fail without taking the entire economy down with them. Firms like Citigroup and AIG should have failed, but the government was forced to throw tens of billions of dollars at them. If it hadn't, the entire financial market would have collapsed.

I support antitrust regulation for the same reason. Monopolies are bad for capitalism. By having government regulators insure that competitiveness is kept in check, the economy functions more effectively.

As much as I hate the government to be involved in the economy, sometimes the lack of its involvement would make things worse. So any regulation that I stand in favor of should serve to make the free market function more effectively -- not to have the government weigh it down. For that reason, I'm highly suspicious of a systemic risk regulator whose chief focus would be to attempt to predict future crises. I think it would ultimately fail and would be a waste of time and money. That doesn't mean that there's no place for systemic risk regulation -- such a regulator just needs to know what it can and cannot accomplish. For example, as mentioned, a new resolution authority would likely play a part in systemic risk mitigation.

I am not at all naïve about the fact that there's little the government can and much it cannot accomplish. As I've mentioned, the government cannot eliminate all risk from the economy, nor should it try. At some point, the cost of regulation becomes greater than the cost that the risk poses. I don't think we're anywhere near that threshold yet, however.

Finally, I also have tried my best to find ways to prevent taxpayers from footing the bill of this regulation. I think it's vital that firms that create the risk, or those that benefit from the profit it may bring, ultimately pay for the risk they take. This will also help keep taxes lower, which ultimately benefits the broader economy.

I believe that the government is hopelessly inept at many of its functions, which is why the suggestions I've made attempt to deviate from the kind of regulators we've come to know and love mock. If the government is going to be in the business of regulating, it needs to attract talented individuals who can actually accomplish the task at hand. That's not what we currently have. It also needs to aim at ensuring that capitalism and the free market flourish. It should not put barriers in their way in the dubious name of protection. Those are the principles I stand for, which I believe are supported by the suggestions I've made.