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And the Regulators Propose: Regulations

May 17, 2004

I’ve just returned from the Security Traders Association’s Washington conference, which had as its featured speaker Securities and Exchange Commission Chairman William Donaldson. 

My editor and I were naturally looking for exciting stories to fill the pages of Traders Magazine. In a sense, we obtained plenty of news. Donaldson gave us tons of juicy things to write about. But, in another sense, we came back with the same tired answers that have been tried in Washington going back at least to the 1930s. That was the period of the disastrous regulatory and economic policies of the New Deal that never pulled the nation out of the Great Depression, an economic calamity caused and aggravated by the misguided polices of the Federal Reserve in the 1920s and 30s. But I must return to Donaldson.

Since our economy has been having its problems—multiple mutual fund scandals, a mixed recovery along with a sluggish stock market that has fallen below 10,000 as I write this—the regulators now are readying their solutions, which will be packaged in a pretty new box but will really come down to the same old tune: Daddy must take care of his reckless charges who always make a mess of everything if left alone.

Take hedge funds. Donaldson noted the explosion of assets. (It is now an $850 billion industry.) Without hedge fund registration, he warned, the nation would be creating "a formula for problems." Donaldson said that was a minimal first step. However, the regulation of anything—like the tentative steps of every government effort from Social Security to Amtrak to coughing up taxpayer dollars for ball teams—always starts modestly, but continues on to huge proportions.

Later on in the history of a regulation or a giant government program, even the lawmakers, nominally in charge, don’t know half of what is going on. Does the average politician, who is not from a state with a big part of the securities industry, really understand the ins and outs of the debate over soft dollars or hedge funds or Reg NMS? Before you answer, ask yourself this: what percentage of lawmakers have ever owned a business, met a payroll or had to worry about the effect on new regulatory costs?

Donaldson assured the audience that the SEC wasn’t interested in how the hedge funds were run. It merely wanted to be sure that "no securities laws were being violated." Donaldson’s rationale for all of this is that many retail investors—through their pension funds—are now investing in hedge funds.

But most hedge funds—although pricey vehicles in which the talent gets big bucks for obtaining a good bottom line—do fine. Most hedge funds aren’t anything like the infamous Long Term Capital Management (LCTM). And even if most hedge funds were dogs, why is it the business of the government to regulate them? Most investors in hedge funds are well-heeled folk who can afford the risks that come with this volatile investment style, which is designed to generate robust returns by taking big risks. I consider it none of my beeswax if someone makes a million dollars in one of these things or loses his shirt.

So why should the government do anything if a hedge fund implodes? And why should it keep some businesses from failing and ignore the plight of others? Then again, why should major league teams get subsidized by the taxpayers, but the average small business be expected to cut it on its own? And why should there be greater regulation of mutual funds because some are badly run and have high expense ratios?

There are plenty of good mutual funds out there with low ratios and excellent long-term returns. Why is there a need for the government to do anything but punish fraud in the minority of financial entities that run afoul of the law?

Why indeed? It is because to pursue a small-government, let-badly-managed-businesses-fail philosophy would mean many fewer regulations. It would mean the average American would dismiss the argument that—because someone or some entity is going to lose a million or a billion dollars—some Wilkins McCawber writ large must be bailed out by the taxpayers.

And, more importantly, to argue this laissez-faire point of view implies that regulatory bureaucracies would be greatly reduced and might be closed up; that the smaller-government promises of countless pols might come to pass. What am I advocating here?

I am arguing that people should be responsible enough to accept the consequences of their actions. I am arguing that, in a market economy that lives up to its name, there must always be a certain degree of failure. I am arguing that the regulators are depending on Americans having no sense of history. I am arguing that they hope the average American has a case of temporary amnesia that prevents him or her from remembering that there have been many fund failures before, followed by a wave of new regulations that led to, well, more fund failures followed by another wave of regulations ad infinitum ad nauseam. Pax vobiscum, friends! 

When the regulators’ solution fails the first time, they’ll keep trying and trying and trying. And it is always the fault of the market or the hedge fund or of soft dollars or of the mutual fund or the limited partnership. By the way, all of these financial institutions and practices evolved, in part, because of rules, regulations, or laws administered or suggested by, you guessed it, the regulators.

Regulators, with their endless often mind-numbing rules that always add more costs to everything, remind me of W.C. Fields. The great comedian, who by the way hated the income tax and big government in general, used to say, "Now don’t tell me you can’t give up drinking. I’ve done it a million times."

At least the great Fields was joking. The regulators aren’t.

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Gregory Bresiger is an editor with Traders Magazine. gbresiger@hotmail.com. See his  archive. Comment on the blog.


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