Quantum Pranx


Who’s Going to Regulate the Regulators?

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by Clif Drok
Originally published March 8th, 2011

The single most dominant theme among political commentators is the belief that government should do something – anything – to fix the financial system. Regardless of party affiliation, there is a near universal agreement that government should be charged with the task of regulating the financial realm in order to prevent another catastrophe.

This unquestioned assumption that government knows best is a surprisingly stubborn holdout from the early days of America’s first Great Depression some 80 years ago when Americans of all stripes turned to government for relief. In the intervening period since the Depression government has proven itself incapable of preventing the regular recurrence of financial market crashes and business recessions.

One would think this would be a strong testimony against the ubiquitous belief that government has the answers for saving the U.S. from its economic fate. Alas, few seem to have learned this lesson of history and there’s reason to believe that this failure will result in yet another Great Depression by 2014.

In the aftermath of the credit crisis of 2008 we’ve witnessed a steady stream of books, articles and political speeches which attempt to diagnose the underlying reasons for the credit crisis and how it could have been prevented. The common assumption behind nearly every facet of the debate is that increased regulation could have prevented the crisis. It’s further argued that additional regulation is required to prevent a recurrence of this disaster.

The core belief embraced by nearly all parties in the debate is that the government is capable of knowing best how to recognize excesses in the financial system and to prevent them from metastasizing. The absurdity of this proposition can easily be seen when you look at the government’s own fiscal condition.

If ever the dictum, “Physician, heal thyself” applied, it would apply in this case to the federal government. This naturally elicits the question as to why an entity that has proven itself incapable of managing its own financial affairs should be entrusted with the oversight of the private sector’s finances.

Quite apart from the obvious question of the government’s competence in monetary matters is the issue of trust.  Why should anyone trust the government to regulate the financial market when it has proven so woefully inept in preventing market crashes and financial debacles in even the recent past?  This is also an extension of the agency problem.

Let’s look at just two agencies of the government, namely the Securities & Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFCT). Both agencies have proven to be unequal to the task of regulating even the simplest aspects of financial market speculation. An argument could be made, for instance, that the SEC helped destabilize the financial system heading into the credit crisis by abolishing the uptick rule, thereby making it easier for hedge funds to create more downside momentum during the 2008 stock market crash.

On the other side of the aisle, the CFTC could have answered the vociferous calls for an increase in margin requirements for oil futures speculators prior to the 2008 commodities crash. If the two federal agencies charged with oversight of the securities and commodities industries are unable to provide even the most basic governance to prevent runaway speculation, why should they be entrusted with even more authority to regulate?

The debate over how much additional regulatory power government should be granted to prevent another financial crash is an apriorism. Instead of arguing how much and to what extent government should be allowed to expand its regulatory authority, the focus should be on critically examining whether or not the government is doing an adequate job enforcing existing rules. Until there is a satisfactory answer to this, the government has no business increasing its purview over the nation’s financial affairs.

Another hue and cry commonly heard these days from pro-government advocates is the “necessity” for raising the tax rate. Supposedly this would better enable the government to heal the nation’s financial and economic situation. One example of this is found in the interview conducted by Charlie Rose in last week’s Businessweek magazine with Nassim Taleb, author of “The Black Swan”.  When asked how the government could fix the economy, Taleb responded: “…you also have to raise taxes.  I’m sorry, we have to raise taxes.”

This is where the discernment of the pro-regulators should be questioned. Increased taxation is a counter-inflationary tool and wasn’t meant to be used as a means of enhancing federal revenues during a recession. To increase the tax burden at this juncture, when deflation is still an underlying problem, would choke off what little economic growth there is.

Quite apart from any consideration of increasing taxes to make up for revenue shortfalls, the real question that should be asked is whether the government can be trusted to responsibly handle an increase in its revenues and use them in a way to prevent another systemic crisis.

Why should the government be allowed to increase taxes when it has repeatedly shown itself incapable of enforcing financial regulations already in on the books? Should we reward the government with additional taxes when it has failed so spectacularly to prevent the last few financial crises and economic recessions? These questions are especially pertinent when you consider that the warning signs prior to the credit crisis were everywhere evident.

In his latest Special Edition, entitled “Crisis High,” Samuel J. Kress makes the following pertinent observation: “Since the Great Depression of the ‘30s, the federal government has increasingly intervened in the economy thereby increasing the national debt to astronomical levels with the numerous social entitlement programs. Will the government’s addiction to OPiuM, squanderous spending of Other People’s Money, ever end?”

Within the context of the current long-wave deflationary trend, more regulation and increased taxation won’t prevent another financial crisis. Legislation is reactionary by definition and can’t be expected to anticipate future crises since it deals only with the problems of the last crisis. At best, new regulation can only address the problems of the past. The “next crisis” is always brought on by a totally new set of problems from an unexpected quarter (from the government’s perspective).

Allowing the government more authority to regulate can only result in an even more cumbersome structure of inefficiency which is of benefit to no one but the regulators themselves.



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