Saturday, December 3, 2011

Financial Regulation

"Deregulation" is blamed for the current economic mess, which is rather absurd, since our economy is heavily regulated.  For example, we have



Regulation is driven by the regulated. When we change regulations, the changes merely serve to create a new set of winners and losers, not assure fair or orderly markets. Note that in spite of all that above, regulators managed to jail Martha Stewart but not stop Jon Corzine or Bernie Madoff. We need not a single one of those agencies nor any of their employees.  We can save hundreds of millions eliminating all of them today, and it would make no difference in the markets, but help reduce our budget deficit.

In a free market there is no need for any government financial regulation of any sort.  The market itself produces counter-parties to mischief makers.  Any financial instrument goes up or down in value, depending on countless variables and human perception.  Investors can go long or short.  In going long, they buy and hold.  In going short, they borrow and sell. Short-sellers believe a stock will drop in price, so they borrow it and immediately sell it at $10, expect it to drop to $2, at which point they will buy it and return it from whom they borrowed it.   Thus the short-seller has earned $8.00.

It was short-sellers, not regulators, who spotted Madoff, Enron, WorldCom, InfoSpace and countless other dubious propositions.  What happens is as short-interest grows, people look closer and it becomes apparent to more and more people what the problem is with a particular company.   If short-sellers are right, they do very well.  If they are wrong, they get burned exponentially (and their target is rewarded by the short-sellers error).

It is the short-sellers who risk their own money when they perceive fraud or foolishness.  In either case, short-sellers believe the price of an asset will drop, and they act on that belief.    Short-sellers perfectly match the activities of the foolish and fraudulent expanding and contracting with the waxing and waning of the players.  You cannot design better regulation of markets than the natural provision of regulation inherent in short-selling.

The fact that we have overwhelming regulations and regulators gives investors a false confidence that their investments are safe.  Our personal faculties of reason and skepticism atrophy, making we investors all the more susceptible to loss.

Regulators are so captured and their views so distorted that during the boom years, when the damage occurred, Beal Bank and Presto were both prosecuted for not participating in the criminal activities.  If either were engaged in mischief, short-sellers would have sniffed them out.  They were, it turns out, being very smart.

Short-selling is necessary and sufficient regulation in market. What we get instead are such "leaders" as the peripatetic Christopher Cox whose tenure as SEC Chairman is greatly admired by those who greatly benefitted from the changes he introduced.  No word from the vast masses of people who were on the losing side of his regulatory changes.

In 2008, for example, those who had shorted financial stocks in response to extremely foolish and criminal acts of the big banks, found that Christopher Cox, in his role as head of the SEC, banned short-selling in order that the banks would be immune to the market that made them rich.  Cox later claimed to regret his actions, but this is silly since at the time he knew what he was doing and no doubt has been rewarded astronomically since then.  If he cared he would disgorge his profits from his "service."

If someone with integrity strives in public service, she (in this rare case) will be frozen out, and find no efforts rewarded.  There is simply no efficacious alternative to free market regulation.


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