Wednesday, January 07, 2009

Regulation and the Debt Bomb

Americans are demanding a more centralized economy with greater regulations. As I look at recent economic news, I find myself asking: Would a strict regulatory regime stop debt bombs? Would stronger regulations have prevented the Madoff Ponzi scheme?

I've come to the unfortunate conclusion that the answer to both questions is "No."

The reason I answer in the negative is that scams such as these are adept at using the trust created by regulators. The scammers start by studying the regulatory and reporting processes. They then present information in such a way that pass regulatory scrutiny.

A confidence scam works by building confidence in a fantasy. The short cut to building that confidence is to dupe or pay off a regulator.

It honest people, who do everything in their power to present clean data to regulators, that get shut down by the regulators. An honest company, whose books reflect reality, will often be present data that falls short of the regulator's ideals, and they pay the price for honesty.

The honest player is wide open for abuse because their backs are toward the truth. The player who is willing to fudge the data to please the regulators fares much better.

On the vein of reality coming up short, it is possible for a strict regulatory regime to end up manufacturing future crises as people feel pressured into presenting the world view that the regulators want to see as opposed to the world as it is.

Looking into news archives, one finds that Madoff, Golden West, FreddieMac Washington Mutual, Enron, Worldcom and many other companies at the center of scandalous business implosions were praised by both the media and regulators before their collapse.

One of the greatest scandals of all occurred during one of the most progressive undertakings in history. Mao's Great Leap Forward (1958-1961) collectivized the entire agricultural segment of China. The political program set extraordinarily ambitious production goals for the members of the collectives.

The commune leaders were tasked with meeting the goals of the five year plan or being denounced as bourgeoisie and struggled against. They shipped massive quantities of food to the central regime, as the quotas demanded. The bureaucrats balanced the books with the stomaches of the people. Estimates of the dead range from 14 to 43 million.

I confess, don't share the progressive view that a centralized society burdened by a restrictive regulatory regime and command and control political structure is paradise.

I disagree with the goal.

Pushing me further from the norm, I think the methodology used to bring about the current transfer of power will end up undermining the new regulatory regime.

The method was to present recent economic history as a foundational dichotomy between regulation and deregulation.

The problem with this mehtod is that it creates deep political divisions. Regulators in societies wracked by deep political divisions are apt to make regulatory rulings for political expediency. In my opinion, a regulatory regime that weighs in political affiliation is ripe for abuse.

I am disenchanted with both the means and ends used to engineer a demand for political change.

I find that I prefer the classical liberal approach.

The classical liberal methology is to find a minimal number of well enforced regulations needed for a functioning society. As it is impossible to derive a perfect set of regulations from the ether, a classical liberal regime is always on the lookout for changes needed in the system. There is always change as society tries new regulations and reject those that fall flat; however, such a system avoids makings changes for the sole sake of change.

Such a system can lead to prosperity. Sadly, such systems get get labeled with the snarl word "conservative."

We don't want prosperity. We want change!


Jason The said...

Maddoff's scheme has nothing to do with the economic meltdown, it was just an act of insensitive greed and hubris.

As for regulation, certainly it would have prevented the securities swapping that lead to the over consolidation of credit swapping into "too large to fail" conglomerates that required taxpayer bailouts to avoid folding and taking our not-any-longer-manufacturing-based financial economy with it.

It's economics 101, not rocket science.

y-intercept said...

I realize that, from a Democrat's perspective, $50B is chump change. Money, after all, is something that you take from others, or just print up.

The credit default swaps, to which you refer, were created by an 11,000 page law signed by William Jefferson Clinton. The generators of the idea all maxed their donations to the Democratic party. (Phil Graham and some other Republicans co-sponsored the bill; So, there is bi-partisan blame).

Considering that an 11,000 page bill fills an entire shelf. I would consider it to be a regulation.

There is an argument that, for credit default swaps to work, there would need to be a massive federal [strike that] international bureaucracy that dictated who could buy the swaps and when. This bureaucracy would be full of altruistic individuals who were above taking bribes and who would not take positions with multi-million dollar salaries when they leave the agency.

I say that, if the new financial instrument that requires an 11,000 page bill to bring into existence also requires a thousand bureaucrat strong regulatory agency to support, then the idea is foolheaded to begin with and should not have been created in the first place.

I've put in a variety of posts that this was a bad idea that failed miserably and needs to be eliminated altogether.

PS: I am glad that people are finally waking up to the mistake we made when we drove our manufacturing sector and industry away. I am sure that you have a small minded partisan way to frame this as a creation of GW Bush.

It's economics 101, as taught by a partisan mind. Economics 401 starts with the sentence: "everything we told you in Economics 101 was a lie."