Deregulation v. Regulatory Capture

My last post suggested that a major reason for our economic woes is that institutional investors were engaged in the absurd activity of trying to hedge their investments with leveraged positions.

If people are engaged in an activity that is causing widespread misery, then it makes great sense to stop that activity.

Demands to regulate Wall Street are headed in the right direction; However, before adding a new layer of regulations, we should look at existing regulations.

All of the derivatives used by these schemes to hedge risk with leverage are the product of regulations. Fixing the problem is more a matter of removing bad regulation than it is adding a new layer of regulations.

Many of the regulations in place are extremely anti-market. This is particularly true of credit default swaps and naked short selling. These bastard children of regulations run amok allow hedge funds to leverage against equities that they do not own. The leveraging often does great harm to the source equity. A long term short position simply increases the float of the stock. I've argued in the past that we could rid ourselves of these scourges simply by allowing the investors who've been hurt by short sellers to sue those who engage in the activity.

Pundits have framed the issue as a case of "regulation v. deregulation." I believe that the site Deep Capture has done a better job pegging the issue. The problem is with regulatory capture.

The regulatory system was first captured by technocrats with the hubris to think their mathematical models could usher in a age of unlimited prosperity and is now held by thugs who benefit from the institutionalized theft that can occur in a captured regulatory regime that allows people to leverage the property of others.

Before adding new regulations, we should look at the captured regulatory regime and remove those regulations that are doing harm.