Would More Muscular Regulation Have Prevented this Mess?

A common refrain in these tumultuous times is that more pro-active, muscular regulation would have prevented some of the excesses of the past few years and perhaps diminished the severity, or obviated altogether, the pain we are enduring at present. Alan Greenspan—admitting that easy money conditions, which were allowed to continue for too long, during part of his tenure earlier this decade—said, in effect, that finding the political will to stop a roaring profit party in a democratic system is virtually impossible. Former Vice President Cheney, while defending President Bush, also seemed to indicate that it is virtually impossible to deflate a bubble with regulation in a democratic system and a capitalist economy. There were simply too many people making too much money, and trying to bring it to an end with more forceful regulation would appear both arbitrary and capricious to those whose livelihoods were being curtailed. In our situation, since so many people were in some way benefiting from the frenzied economy, the political repercussions of stopping this dance would have likely been enormous.

Today, testifying before Congress, Paul Volker, the chairman of the President’s Economic Recovery Board, called for beefed up regulation to stem future crises.

“The first and most fundamental lesson of the crisis is that future policy should be alert to, and take appropriate measures to deal with, persistent and ultimately destabilizing economic imbalances. I realize that is a large and continuing challenge of international as well as domestic proportions, but it is the essence of prudent economic management,” he said.

Would more muscular regulation have prevented this mess? In all honesty, the Bush years were hardly the lawless, “Wild, Wild West” that many would like to portray them as. Sarbanes-Oxley was signed into law by President Bush. Regulatory agencies were not gutted during his watch. Spending priorities may have been elsewhere, but to be fair, in the post 9/11 world, most Americans understood where the real priorities should be.

Also, to be fair, the President did try to reign in Freddie Mac and Fannie Mae. These efforts were blocked, largely by Democrats in Congress—many of whom now decry the lack of more hefty regulation.

Today, Germany faces as much pain, if not more than does the United States. Germany’s economy is perhaps one of the most regulated in Europe. German banks, it turns out, made many bad decisions, despite the heavily managed nature of the German economy. More muscular regulation did not prevent Germany from the pain of this situation. It will be interesting to observe how quickly the anemic European economies emerge from this misery.

And laws and regulation did not prevent Bernie Madoff and other others from running alleged Ponzi schemes. There were Securities and Exchange Commission audits on his firm, and everything appeared to have checked out alright. The securities business is one of the most heavily regulated in this country and yet criminal activity was apparently more prevalent than we would like to think.

Regulation in and of itself will not prevent fraud or preclude market bubbles. It is a necessary component of our system of commerce, but don’t kid yourself about its possibilities. Imagine instead a marketplace of banks all competing with each other but with minimal state-imposed restrictions on or requirements to lend. Imagine that in this system there were no FDIC insurance. Investors had to rely solely on the skill and probity of the bank’s management when placing money on deposit. Would such a system have made the ruinous decisions that now haunt us all? More than likely, it would not. And the banks that did lend poorly in such a regime would likely soon fail, while the more soberly run would grow at their expense.

In time of scandal, people always clamor for tougher regulation. However, new regulation will not help grow us out of this mess. And new regulations will not likely smooth out the boom and bust cycle of business. It may feel good in worrisome times to talk of an army of government regulators, marching to save us from ourselves. However, if the Obama administration really wanted to help the country get back on its feet, it would do well to focus on more productive components of the economy than regulation.

Would More Muscular Regulation Have Prevented this Mess?

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

Ockham Research provides its research in a variety of forms and products including our company specific reports, portfolio analytics tools, newsletters, and blog posts. We also offer a white labeling research solution that can give any financial services firm their own research presence without the time and cost associated with building such a robust coverage universe of their own.

Be the first to comment

Leave a Reply

Your email address will not be published.