A further problem with governmental regulatory agencies is that they undermine the operation of the most effective regulatory agency of them all: the free market. The free market rewards those who produce and punishes those who do not. And does this far more effectively than any regulatory body from Washington.
One way government regulation short circuits the free market is by increasing the cost of doing business. Complying with regulations is costly, and this favors large existing firms over smaller ones without the deep pockets. For example, if a broker/dealer wants to do business in a certain state, both the firm and its agents must register with the securities agency in that state. This imposes a significant cost on the broker/dealer both in the time spent dealing with paperwork and the money required to purchase the license. Large, established firms can bear these costs more easily than their upstart potential rivals. In a free market, an investor could easily leave a high priced, under performing broker or investment adviser for one that gives him better service. But by restricting entry into the field, government regulations create a market where there is less competition. This shields incompetent established firms from losing business to better run but smaller competitors.
Government regulations can lull consumers into a false sense of security, thus blunting the salutary effects of the free market. Bernie Madoff, perhaps the most egregious rip-off artist in history, enjoyed a good reputation with the SEC (Securities and Exchange Commission), the federal government’s regulatory body tasked with protecting the public from financial fraud. According to reports, the SEC was warned about Madoff’s phony practices as early as 1999, but did nothing to investigate the matter, let alone put a stop to the abuse. This is astounding. The agency, whose job it is to protect the public from unscrupulous investment advisers, completely dropped the ball in the biggest fraud case ever. If Madoff’s clients had trusted less in the SEC and instead had more incentive to keep in mind the notion caveat emptor, perhaps today we would have fewer outraged ex-millionaires trying to put their lives back together.
Gordon Clark argued that man does not learn from experience, and the Madoff case is a perfect illustration of this principle. For ironically the SEC’s failure to prevent Madoff’s crimes is being advanced by some as a reason for more federal oversight of the financial industry, and this, for the purpose of preventing fraud! While this conclusion certainly seems absurd at first glance, it is not as unreasonable as it sounds. For apart from a political philosophy based on Scripture, there is no logically valid reason to oppose more regulation of the securities industry. After all, it can always be argued that the SEC failed, not because of any inherent flaw in the agency, but because it didn’t have enough authority and money to carry out its task. Until we abandon the notion that government’s job is to prevent crime, and once again recognize the biblical principle that the magistrate’s proper function is to punish wrongdoing, the regulatory state will continue to grow, personal freedom will continue to shrink, and we all will be the poorer for it.