I’d like everyone to go out and buy a copy of Professor Paul Mahoney’s slender new book, Wasting a Crisis – Why Securities Regulation Fails. Paul is a brilliant guy. Until this spring, he was the dean of the University of Virginia School of Law where he is the David and Mary Harrison Distinguished Professor of Law and the Arnold H. Leon Professor of Law, teaching securities laws. This is a great book and an important read. Paul argues cogently that:
- Securities regulations rarely perform as intended and always generate negative unintended externalities.
- Massive regulatory undertakings such as the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, the Sarbanes-Oxley Act and Dodd-Frank are often credited with successfully fixing “the problem” that had inspired (or excused) the passage of these laws. These voluminous and complex statutes are always passed in the lee of a market disruption, and the recovery that follows, often little more than a reversion to the mean, is conflated with the efficacy of the new law. The causality arrow is backwards. Because markets repair following a crisis, reform appears to make things better. The counterfactual is not available to test this successful narrative nor, regrettably, to prove that the recovery would have happened anyway and the new law would have actually made the recovery less robust.
- Rulemaking is always defended as a necessary prescription for market failure, but perceived market failures are often the result of governmental action. Professor Mahoney calls these “governmental failures.” Think of the GSEs and the pressure from Congress and the administration to foster an ownership society and how it led to the excess of the subprime market bubble. It’s so much easier for our elected officials and their regulatory apparatchik to find market failures than governmental failures. For pointing out this Emperor’s New Clothes fact, I suspect Professor Mahoney won’t be on Congressman Frank’s Christmas card list any more.
- Financial regulations should in some significant measure be seen as a way of deflecting public anger from governmental failure. Do something, they cry! There must be bad guys, tell us who they are! And so a simple tale of good guys and bad guys is spun. Oddly, our elected leaders rarely cast themselves as the bad guys.
- Wall Street and banking have always been the favorite whipping boys of the professional populist yet they are in large measure only the messengers of distress; they are the medium by which financial distress is transmitted to the broader polity. Shoot the messenger is fun and easy!
- Regulatory incursions into the economy always create winners and losers.
- And who are the winners? The unintended or perhaps even intended consequence of governmental regulation is often to actually encourage concentration in markets and favor larger economic enterprises able to “partner” with an activist government. A virtuous circle: first create a market failure narrative and ignore any government failing, then propose massive regulatory intervention, which imposes massive compliance costs, which causes market concentration, which justifies more regulation. Regulating huge, oligopolistic enterprises: that’s the next best thing from owning them outright. Command and control is much more fun than just a robust competitive environment if you’re one of those who gets to command and control.
As I said, a great book full of fascinating observations and insights about how markets function, how the government interacts with the markets and the mistakes that have been and continue to be made. The analysis is detailed, the math all escapes me, but the conclusions are compelling.
We have written often in our commentary about the unintended consequences of regulatory action and this book provides a compelling intellectual framework for understanding why the regulatory state grows in the first instance and why it so often fails.
In any event, I heartily recommend this book to anyone interested in understanding where we are and where we likely are going as the regulatory state continues to expand. There is no doubt that it will continue to expand, seemingly regardless of the party affiliation of those with their hands on the levers of power. It will continue to be excused by false market failure narratives, it will be blithely indifferent to the unintended adverse consequences and externalities of its implementation, it will result in increased economic concentration as big business and big government are more and more closely married, it will actually create more interconnectedness and create more opportunities for systemic failure and will create winners and losers. Perhaps we should be focusing on how this can be stopped, how the rules of the game can be changed, how a smaller, less intrusive, less hubristic government could do a better job of shepherding a great and vibrant economy. But until those halcyon days arrive or a champion arises to tilt at that particular windmill, it’s our job to figure out how to play the game and make sure we end up as winners. Easy, right?