Lux Lucet

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.

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In his epistle to the Romans, Paul, commenting on the proper function of government, described the civil magistrate in this way, 

he is God’s minister, an avenger to execute wrath on him who practices evil (Rom.13:4).

For Paul, the job of government was to punish crime, not prevent it.  This was also the view of the founders of our nation, who established a system of limited, republican government that did not burden the people with endless regulations and red tape.  But as faith in the God of the Bible waned, and faith in the false god of the state grew, people began to demand more and more the government at all levels.  One of these demands was that the government take an active hand in the prevention of wrongdoing, and thus was born the modern regulatory state.

By way of example, I’ll reference something I recently came across while studying for my Series 6 securities license.  In the Kaplan course I used, I found the following paragraph,

Investigation of the conditions that led to the 1929 market crash determined that investors had little protection from fraud in the sale of new issues of securities and that rumors, exaggerations, and unsubstantiated claims led to excessive speculation in newly issued stock.  Congress passed the Securities Act of 1933 to require issuers of new securities to file registration statements with the SEC [Securities and Exchange Commission] in order to provide investors with complete and accurate information.

The impression left on the reader is that the cause of the crash of 1929 was the lack of proper government supervision of a rowdy, out of control securities industry.  The free market and limited government failed to protect investors; the state had to intervene.   This is perverse for at least two reasons.

No doubt there were then, as there are now, crooked brokers and financial advisers.  But this was not the cause of the crash.  The blame can properly be put on the incompetent central bankers (but I repeat myself) of the Federal Reserve, who erred in contracting the money supply too quickly after having expanded it too much earlier in the 1920s.  Monetary expansion created a bubble in stocks, and when the Fed cut off the money supply, the bubble deflated, leading to the October 1929 crash.  But just as it’s easier today for politicians to heap blame oil companies for high gas prices rather than admit that their policies are largely responsible, so it was easier then for Congress to point the finger at securities dealers instead fessing up to its foolishness in creating the Fed. 

Second, regulating everyone to prevent the wrongdoing of a few violates the biblical principle  no crime, no punishment. The Old Testament required thieves to pay for their crimes, not by jail time, but by restitution plus 20% to their victims (Lev.6:1-7).   The system was just, applying punishment to the guilty and leaving the innocent alone.   On the contrary, the regualtory dragnet ensnares everyone, punishing the honest as though they were guilty, all for the sake of preventing some unknown future crime by some unnamed future ne’er-do-well.   And this is far from biblical justice.

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