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Regulatory Rot

July 19, 2002

Harvey Pitt should just give up.

Once again, our government is pursuing a futile quest. The idea of regulation has never and will never work effectively. Still, the regulators always say we need more of them, despite a record of failure as enviable and consistent as that of the Chicago Cubs or the pathetic New York City Board of Education.

It is time to think the unthinkable: Forget about the system of regulation; consign it to the garbage bin of history.

Yes, it's time to think about closing down the SEC, along with a myriad of other regulatory bodies. It is time to ask the same question of the regulators that we, the citizens who pay for all this, should be asking of every level of government: Just what, exactly, are these tens of thousands of people accomplishing? I mean, besides providing themselves with nice salaries, prestigious offices, and the power to destroy businesses.

The trading industry supposedly was riddled with price-fixing, according to a controversial study that the government used to justify its order-handling rules. These rules were a reform designed by regulators to fix the problem, real or imagined. The rules gave an impetus to electronic communications networks (ECNs), which became the darlings of the regulators. ECNs were the entities that would compensate for the supposed wrongs of market makers. In the late 1990s, ECNs started to take much business away from market makers. The regulators had succeeded.

Well, not exactly.

Now a new trading platform is in the process of starting up, with the blessing of the regulators. The SuperMontage will provide liquidity and transparency to the market. It will become the ultimate ECN. It will also be run by a former regulator--one that is about to become a for-profit exchange--called Nasdaq. This is a development fraught with potential problems, as Nasdaq will have advantages that it has not earned in the marketplace.

Already, the same ECNs that benefited from the favors of regulators in the 1990s are complaining that this new regulatory system will be rigged against them. Many market participants, in effect, could be forced to use SuperMontage, especially if the Brand X alternative to SuperMontage, the Alternative Display Facility (ADF), is not ready in time. The latter is the responsibility of another regulator, the NASD, which used to be the parent of Nasdaq but, as it goes private, has retained a small stake in Nasdaq. (Listen, this stuff is so convoluted that I couldn't make it up if I had the collective talents of a Sinclair Lewis, Joseph Conrad, F.A. Hayek, and Liam O'Flaherty.) How much does one want to bet that, if and when SuperMontage and ADF start operating, the regulators will require another regulatory scheme to correct the problems of these latest regulatory wonders?

Regulation, whether it involves railroads, trading, or software, is so incredibly involved that, inevitably, it must end up requiring new rounds of regulations to fix the first round of regulations. Regulation--like civil rights laws--has no timetable. It is designed to go without end. There is never a regulatory scheme that is designed to fix a problem once and for all, just as affirmative action will go on forever and then close up shop.

That is because the nature of public bureaucracy is self-perpetuating. In William Safire's book "Before the Fall," which was a chronicle of his years in the Nixon administration, Safire tells the story of useless tea regulatory board that some six U.S. presidents--Democrat and Republican--had unsuccessfully tried to jettison. Every time the tea board was marked for death, some congressman would put it back in the budget; it would survive because, after all, who would hold back an entire federal budget for a dinky little board? Even the powerful Nixon, at the height of his power before Watergate, couldn't get rid of it. To a much greater extent, the SEC has been as ineffective and as useless as that board. It should go.

The SEC, along with every other regulatory body, is based on a specious premise. It is based on the principles of the Sherman Act, which was passed in the late 19th century and was designed for an economy that was dominated by railroads. That economy no longer exists, yet our economy is hampered by the antiquated notions of that law.

Here we see the futility of regulation. It can't keep up with a dynamic economy, an economy that is changing much faster than the regulators, even if the regulators were men and women worked 24 hours a day and were imbued with the wisdom of Kant. Then again, the brilliant philosopher Immanuel Kant was a man of modesty.

The idea of regulation is not based on modesty and limitation. It is based on the idea that regulatory bodies are all-knowing; that they are run by men and women of limitless wisdom, who know, for example, when to favor ECNs at the expense of market makers and vice versa. All of them labor under the delusion of the Sherman Act, which states in Section I, "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among several States, or with foreign nations, is hereby declared illegal…"

So, individuals or businesses working in their own self-interest to obtain a better price or higher profits may be deemed by regulators to restrain trade. But how does one objectively apply this law, free of political prejudice? This is tantamount to asking how can one eat a pint of Haagen-Dazs once a day for a month and not gain weight?

One can't.

These regulatory laws allow a lot of leeway for interpretations that mean the difference between leaving a company alone or filing a lawsuit that can cost hundreds of millions of dollars to defend. And how exactly does one know that "self-interest" has become "restraint of trade"? Maybe the best thing for a market sometimes is for one giant, efficient firm to provide the best price and quality of service, provided, of course, that anyone is free to start a competing service. And, more important, how does one know that the people administering our regulatory system do it in an objective, fair-minded, apolitical way?

History tells us that they don't. So the Clinton Justice Department believed Bill Gates and his Microsoft Empire are the moral equivalent of Lucifer. By contrast, the Bush Justice Department, administering the same laws, believes that the company has committed no crime. Someone must be wrong. Was the Sherman Law changed?

No, the politically interpreted nature of this law changed with the change of administrations. So the Lyndon Johnson Justice Department claimed that IBM was violating the law, but the Nixon Justice Department--all sworn to administer these same laws--said the lawsuit was no big deal and settled it on easy terms.

The quixotic, insane quest of regulators will continue just as long as these laws are on the books and as long as these regulators feel compelled to impose a dictatorship of virtue. Most of the people in Cervantes's delightful novel "Don Quixote" could see that this poor man was crazy. Are Americans ready to understand that our regulatory masters are charging into windmills? That their golden helmets are nothing but shaving basins? That their schemes are about a century behind the times?

I would rather take my chances with the IBMs, the Microsofts, or even the Nasdaqs of this world. After all, no one forces me to buy Gates's software or IBM's product or to use Nasdaq's trading platform. Unfortunately, the government can and does force me--through the coercive power of taxation--to pay for its wretched bureaucracies, whose only products are inefficiency, politics, and endless confusion.

Let Harvey Pitt and his minions go into a useful line of work. If they're afraid of the private sector, then let them contact me right here. I'll be happy to help them find work.


Gregory Bresiger, a business journalist, is assistant managing editor of Traders Magazine. He has also written for the Free Market and the New York Post. See his Mises.org Articles Archive, and send him MAIL.


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