Posted by: N.S. Palmer | November 9, 2008

Back to Regulation: Part I

By N.S. Palmer, Ph.D.

For most people, the economic meltdown of Autumn 2008 is confusing. The one thing on which almost everyone agrees is that inadequate regulation of financial institutions was a big part of the cause.The only people who don’t agree on that point are either blinded by ideology (libertarians) or are in the pay of the corporate state (establishment conservatives, not to be confused with the millions of people who believe in conservative ideals).

So after eight years of the Bush-Cheney administration’s Wild West show have almost bankrupted the United States and the world, we’re going back to regulation. It helps to know how we got here and why.

Thirty Years of Deregulation

As much as I’d prefer to blame it all on Bush and Cheney, they didn’t invent the idea of letting banks and giant corporations do whatever they want. It had been around for at least 30 years. The Bush-Cheney agenda was merely the reductio ad absurdum of deregulation, pushing the idea to insane limits — appointing corporate shills to run regulatory agencies, under-funding and under-staffing the agencies, censoring scientific reports, and so on.

Since the 1970s, two groups have supported deregulation of business.

First, there were economists and policymakers who sincerely believed that deregulation would improve life for most people. They were wrong — but back in the 1970s, it was an easy mistake to make. Regulation did impose some costs on the economy. For example, before deregulation:

  • Airline travel was more expensive. Most middle-class people could do it, but it cost more than it could have. There were a few large airlines and a large number of smaller airlines. None of them was allowed to compete on price: in the U.S., ticket prices were set by the Civil Aeronautics Board. Because airlines couldn’t compete on price, they competed on offering the best service. Sincere supporters of deregulation thought that it would make air travel cheaper, and it did. They didn’t foresee that deregulation would turn what had been a pleasant experience into a nightmare for everyone except first-class passengers. They didn’t foresee that deregulation would spawn notoriously poor service, cramped and uncomfortable seating, unreliable connections, unsafe aircraft, cancelled flights, and bankrupted airlines.
  • Banks were open only for limited hours, never on Saturday, and offered relatively low interest on savings accounts. Interstate banking was tightly regulated and generally prohibited. Sincere supporters of deregulation thought that it would let banks put depositors’ money into more profitable investments and offer higher interest rates. By enabling national and regional banks to enter local markets, it would force local banks to improve their offerings and customer service. They didn’t foresee that it would enable big national and regional banks to muscle out their small-fry local competitors until there would be hardly any local banks left — hardly any banks with roots in the communities they served and some degree of loyalty to those communities. They didn’t foresee that bank executives would pay themselves huge bonuses for risky but “profitable” investments that later went bust, then turning to the taxpayers to bail out their banks while they walked away with the money.
  • Local stores sometimes charged high prices and had limited selections. Sincere supporters of deregulation thought that allowing national and multi-national corporations to dominate local markets would increase competition, result in lower prices, wider selections, and better quality for consumers. They didn’t foresee that it would enable giant corporations to get tax breaks that forced their smaller competitors to subsidize them. Or that the corporations would pay low wages and provide no employee benefits, relying on tax-supported welfare and medical care programs to make up the difference and thereby subsidize their labor costs. Or that big-box stores would, after wiping out their local competitors, bankrupt American manufacturing by giving preference to cheap, low-quality merchandise made by virtual slave labor in third-world countries.
  • Local news media sometimes gave readers and viewers one-sided versions of the news. Sincere supporters of deregulation thought that allowing national and multi-national media corporations to buy up local newspapers, radio stations, and television stations would provide more viewpoints and more reliable news. Instead, it has given the media corporations a stranglehold on any viewpoints they don’t like.  Once upon a time, newspapers and other local media were owned by local millionaires whose primary goal was not to make money but to be influential “big shots” in their communities. They provided newspapers with adequate resources to do their jobs, and supported them in reporting news even if it was unpopular with the government — as long as it was a “scoop” that would enhance the owners’ reputations. Now, newspapers are owned by national and multi-national conglomerates who squeeze every possible penny of profit out of them and try to keep reporters from writing anything that would offend the government. They have loyalty neither to the local community nor to the truth — only to their bottom line.

In addition to the group I’ve referred to as “sincere supporters of deregulation,” there was a second group. They had fewer doctorates and wrote fewer books, but they saw the future much more accurately than the first group. These were the owners and managers of giant banks and corporations. They correctly foresaw that deregulation would give them carte blanche to pillage the economy and destroy most of their competition. Any temporary savings or additional choices for consumers would disappear as soon as the competition was eliminated. That’s why this badder-but-wiser group funded think tanks, policy studies, research grants, and publications to push for deregulation.

There’s no doubt that regulation has its costs. So does deregulation. The events of September – October 2008 showed that the costs of deregulation are much higher than those of sensible and adequate regulation.

What is Regulation?

But what is regulation? Unregulated markets, in spite of their name, could not be mere free-for-alls in which anything goes. If they were to function at all, they would have to be governed by laws or, if one prefers a term less weighted by historical precedent, rules. Even the most dedicated anarchist wants rules of some sort, enforced in some way, against fraud and perhaps also against egregiously unethical business practices. With no rules at all, society and markets could not function. Rules restrict freedom, though such restrictions are not necessarily a bad thing: few people would argue against rules that restrict individual freedom, for example, to shoot people at random or play Celine Dion songs in public.

However, an even more important function of rules is that they codify and clarify how participants in society and market are expected to act.

For example, suppose that someone sells you a horse. At the time he sells it, he knows that it has a deadly disease that will kill it within a month. However, he never denies that it has the disease, so he doesn’t actually lie to you. He simply doesn’t say anything at all about the disease. On whom does the obligation fall?

  • On him, to inform you about the horse’s disease?
  • On you, to investigate the horse thoroughly enough to detect the disease?

Likewise, suppose that someone sells you an investment package. The package contains some investments that are riskier than you, as a customer of a “reputable brokerage,” probably believe. The seller knows that they are risky, and he has done some things that hide the risks. However, as a human being with a financial interest in the deal, he rationalizes that the investments are safer and more profitable than they appear. On whom does the obligation fall?

  • On him, to inform you of the risks?
  • On you, to investigate the investment package thoroughly enough to discover the risks even though (a) they are hidden and (b) they might require considerable financial expertise to understand?

I’m quite honestly not setting up those alternatives as straw men, to show that one choice is absolutely better than the other. I would argue that the correct choices cannot be deduced from broad moral principles alone. Instead, they grow out of the culture, morals, and historical practices of a particular society. If you’re living in a society where honor and honesty are expected, then the obligation falls one way. If you’re living in a society of Ferengi, which is the way we’ve been heading, the obligation falls a different way.

Different sets of rules have been regarded as “successful” by different cultures at different times. It is therefore not the case that only one unique set of rules fits all times, places, and peoples. Thus, below the level of broad moral principles, there can be quite a lot of variation in the rules (legal, social, and otherwise) adopted by different societies and groups. Even at the level of broad moral principles, one sees some variation. For example, a Roman citizen who killed a slave might, at worst, have had to pay a fine: yet, Rome was quite successful in its way. The Romans certainly thought so.

In a society of perfectly rational beings, who could objectively and accurately judge their own cases, you’d only need three rules (if any):

  • Don’t coerce other people.
  • Don’t commit non-defensive acts of violence.
  • Don’t defraud other people.

Those rules — essentially the platform of the Libertarian Party — would undoubtedly work in Heaven or in fictional settings such as Ayn Rand’s “Galt’s Gulch.” But Earth, populated as it is with imperfect beings who are impulsive and self-deceiving when it comes to things they want, is another matter.

Therefore, even in markets that style themselves as “unregulated,” certain questions have to be answerable by and/or for the participants. I’m not saying that people will explicitly think out these questions and answers in advance. Most likely, the questions and answers will be implicit in practices that arise over time:

  • Should markets be governed by rules? (Yes.)
  • What purposes do participants want the rules to achieve?
  • What are the proper scope and subject matter of the rules?
  • What do participants consider sufficient justification for adopting a particular rule? Tradition? The Bible? Utilitarian considerations? A democratic vote? Some combination of factors?
  • What are the rules?
  • Who decides on the rules, and how?
  • Who enforces the rules, and how?
  • Who adjudicates disputes, and how?
  • Under what circumstances, and by whom, can the rules be changed?

“Wild West” Markets vs. Honest Markets

When I used the term “Wild West” an earlier blog article to describe deregulated markets, I meant you can make an argument that such markets are fair as long as you very publicly announce their principles:

  • You’re strictly on your own (unless you’re rich and politically connected).
  • If someone cheats you, then it’s your own fault for not being careful enough.
  • If a corporation buries an abusive clause on page 17 of a 25-page contract in legalistic double-talk, and you get burned, then it’s your own fault.
  • There are no laws governing product quality or workplace safety.
  • If a product kills you, then your family can sue the seller for damages in a court that’s biased in favor of the seller. The seller might be hurt by all the bad publicity, if the corporate news media publish any, which they probably won’t. If there is a significant amount of bad publicity, the company can change its name and very few people will be the wiser. Tough luck.
  • If an investment firm hides risks and defrauds investors, then the investors are to blame. Regulating investment firms would hamper the “free market.” If the investors had been smart, they would have bought gold. People who aren’t smart deserve no protection or sympathy.

One can argue that such a system would be fair, simply because its Hobbesian philosophy would be publicly announced and generally known.

However, that’s not the system we have. People still have some expectation (often unwarranted) that businesses will act honestly. As a result, they fail to read all the “fine print” in their credit card contracts and so forth. Corporations take advantage of that expectation in order to cheat people, though of course they’d say it’s not really cheating because they did inform their customers (on page 17 of the latest updated 25-page contract in legal gibberish) of what they were doing. A new book calls this “gotcha capitalism.”

Regulated Markets

Now, let’s consider “regulated” markets. We’ve already established that even “unregulated” markets must have rules. How, then, do regulated markets differ from unregulated markets?

People often distinguish between “laws” passed by the legislature and “regulations” issued by agencies of the executive branch. However, a rule’s origin has no necessary connection to its content. A legislature can issue detailed specifications about how particular economic activities are to be carried out, while an executive agency can issue rules that state general guidelines and goals. Identifying regulations based on their bureaucratic origin gives us no useful basis on which to distinguish between regulated and unregulated markets.

In fact, I would suggest that the distinction between “rules” and “regulations” is ipso facto a difficult one to draw. Are minimum reserve requirements for banks rules or regulations? Libertarians usually support a regulation (though they don’t like to call it a regulation) requiring banks to maintain 100 percent reserves. What about forbidding investment packages that deceptively hide risk? What about requiring credit card contracts to be written in plain English instead of impenetrable legalese? What about requiring drugs to be tested for safety and efficacy? And because rules can be enacted for various purposes, what about requiring banks to make loans to high-risk individuals because of racial preferences? Some rules are adopted on social or moral grounds, but have economic drawbacks.

If the choice of rules is left up to managers of corporations, they will select rules that maximize their own freedom of action while giving the least possible freedom of action and the least rights to their customers, employees, and stockholders. That’s not because corporate managers are bad people, though they sometimes are: it’s because they are people. If they want X, they believe (or can talk themselves into believing) that it’s right for them to have X, and right to do whatever it takes to get X.

The Fundamental Reason for Regulation

In a sense, the main reason for having general rules or regulations is that people shouldn’t be allowed to judge their own cases. If I want to engage in a sleazy business practice, I can probably rationalize it because my desire biases my judgment. That’s why third parties, acting in a legislature or bureaucracy, need to say “You can’t do that.”

Does regulation always work out for the best? No. Are the third parties always honest, rational, and informed? No. But is it a better system than letting each person decide on his own rules? It seems quite clear to me that the answer is yes.

Next Week … Part II

Next week, I’ll examine the history of regulation and deregulation to show how we got where we are, and how we can re-regulate to achieve a fairer, more honest economy for everyone.

About the Title of This Essay 

The title of this essay was suggested by the book Back to Newton by George de Bothezat. Published in 1936, the book tries to show that Albert Einstein’s theories of relativity are self-contradictory and absurd. Today, most people don’t realize that de Bothezat’s views were common among mainstream physicists of the early 20th century. They were accustomed to thinking in terms of the Newtonian model, at least as it was revised and updated by James Clerk Maxwell. They didn’t know what to make of Einstein, with his peculiar definitions of time and space.

Copyright 2008 by N.S. Palmer. May be reproduced as long as copyright and URL ( are included.

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