Coyote Blog

One argument about regulation that seems to be gaining traction through the recent financial crisis is "See, private action and enterprise is not infallible.  They can make mistakes that have costs for everyone.  Therefore they need to be regulated." 

I don't have time for the full refutation of this, but a few thoughts:

• No one ever said that private actors in the economy are infallible or even universally honest.  However, no one has ever been able to make the case that government employees are any more infallible or honest. 
• There are a couple of reasons government regulators are going to be demonstrably worse than the marketplace in making decisions.  The first is information -- a few actors in Washington can never have the same access to information as thousands of actors across the country or around the world.  The second is incentives -- while regulatory hawks cite private greed as a bad incentive in the marketplace, bureaucratic incentives can be at least as problematic.
• Governments are subject to all sorts of rent-seeking initiatives, not to mention regulatory capture, that undermine regulatory effectiveness.  Just look at the bailout bill. Wooden arrows?

For some reason, the argument "private actors screwed up" seems sufficient justification for regulation.  The burden of proof should instead be "the government could have done better."

Here is a nice example of how regulation really works, from an interview with Warren Buffett:

QUICK: If you imagine where things will go with Fannie and Freddie, and
you think about the regulators, where were the regulators for what was
happening, and can something like this be prevented from happening
again?

Mr. BUFFETT: Well, it's really an incredible case study in regulationbecause
something called OFHEO was set up in 1992 by Congress, and the sole job
of OFHEO was to watch over Fannie and Freddie, someone to watch over
them. And they were there to evaluate the soundness and the accounting
and all of that. Two companies were all they had to regulate. OFHEO has
over 200 employees now. They have a budget now that's $65 million a
year, and all they have to do is look at two companies. I mean, you
know, I look at more than two companies.

QUICK: Mm-hmm.

Mr.
BUFFETT: And they sat there, made reports to the Congress, you can get
them on the Internet, every year. And, in fact, they reported to
Sarbanes and Oxley every year. And they went--wrote 100 page reports,
and they said, 'We've looked at these people and their standards are
fine and their directors are fine and everything was fine.' And then
all of a sudden you had two of the greatest accounting misstatements in
history. You had all kinds of management malfeasance, and it all came
out. And, of course, the classic thing was that after it all came out,
OFHEO wrote a 350--340 page report examining what went wrong, and they
blamed the management, they blamed the directors, they blamed the audit
committee. They didn't have a word in there about themselves, and
they're the ones that 200 people were going to work every day with just
two companies to think about. It just shows the problems of regulation.

The problem, of course, is that Fannie and Freddie were doing exactly what Congress wanted them to do -- systematically lowering mortgage underwriting standards.  They won't put it that way now, but that is  what spreading home ownership to lower income families really amounted to.