Financial Sector Regulations Are Important

Here is another question about my article The Myth of Deregulation. Yesterday, I wrote about the number of regulations out there. Today, another reader asks:

“What makes you think that central planners will do what you ask of them in the last paragraph? What incentives does the government have to make good regulations? Do good regulations by the monopoly state possibly exist?”

Here is my response:


I honestly have little hope that regulators will not move forward with their plans. The best political bet at this point is to carefully pick our battles and try to avoid legislation that will cause major problems, such as the GSE creating systemic risk council.

That said, remember that regulations, in principle, aren’t bad. We need “rules of the game” and one of the most fundamental roles of the government is to protect property rights. This role extends the financial sector where there is a very real role to prosecute fraud and ensure a framework for just competition. There are also private groups that contribute to the regulatory process, such as the FASB and FOMC, and this is a good aspect of the system. What is most important for any regulator is that they design rules that encourage and promote competition without skewing the market in one direction or another with perverse incentives.

As to what incentives the government has, the first is that a destabilized economy doesn’t bode well for those in power. Politicians who want to maintain office have every incentive to design good regulations. The problem is that the political process also suffers from a tragedy of the commons issue in that some legislators can hide in the process and let special interests skew the rules. The best rules have generally not come from lawmakers, but issued directly by the regulatory agencies, who also have the incentive to do well in order to keep their power. The problem is that regulations designed in good faith aren’t always the best, as we know and have seen.

Thanks for reading Reason,

I should also note that, when it comes to the Democratically controlled Congress, anything could happen. As it stands now, there is going to be a lot of trench warfare in the Senate and significant battle in the House. If there was a Republican presidency the process might be different, but the Obama administration is going to take a lot of personal interest in this issue and drive it forward.