OT ~ More Regulation?

Here is a thoughtful article by a very qualified individual. People
like Bobby Fiction who advocate more government interference in the
free market ought to read it carefully.
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From the OPINION section of today's Wall Street Journal


Regulatory Overkill
By ALLAN H. MELTZER
March 27, 2008; Page A14

The claim that deregulation went too far is coming from many sides. We
need more regulation, the argument goes, and even a single regulator
to bring stability. Former SEC chairman, Arthur Levitt, Jr., made some
of that case on this page. House Financial Services Chairman Barney
Frank has prepared legislation, and others are rushing forward with
their own plans.

Their diagnosis is wrong. Mistaken regulation contributed greatly to
the current problems in financial markets. Take the 1970s Basel
agreement between developed country governments, which followed bank
failures in Germany and the U.S. The idea was to have equivalent risk
standards in all the principal lending countries. The agreement
required banks to increase their capital if they increased mortgage
loans and other risky assets.

The banks responded, however, by developing instruments that avoided
higher reserves by moving risky loans off their balance sheets. Risk
moved to all corners of the global marketplace. We find out who holds
the risky assets when they announce they are about to fail.

The response to the Basel regulation is not unique. The first
principle of regulation is: Lawyers and politicians write rules; and
markets develop ways to circumvent these rules without violating them.

The financial markets offer many examples. In the 1970s, Federal
Reserve Regulation Q restricted the interest rate that banks and
thrifts could pay depositors. In response, the market developed money
market funds that circumvented the regulation. In the late 1980s, the
government set up the Resolution Trust Corporation to buy the
mortgages held by failed thrifts. The result: Most of the thrift
industry was eliminated and the taxpayers ended up taking a loss of
about $150 billion in the early '90s.

The perennial argument of regulators is: "If only I had more power. .
.." Not so. Regulators did not see the chicanery at Enron. Nor did they
prevent the dot-com bubble or the Latin American debt problems in the
1980s. A main reason is "capture" -- when the interests of the
regulated dominate the interests of the public.

Capture is not the only reason regulation often fails. Regulators and
most politicians are good at developing rules and restrictions, but
poor at thinking about the incentives that the market will face. If
the incentives are strong, the market circumvents the regulation. The
Basel regulation encouraged a system that is far less transparent than
the system it replaced.

Anyone can see where increased regulation leads. The Bush
administration abandoned its commitment to rein in the government
sponsored enterprises. Instead it increased lending by Fannie and
Freddie. This moves risky loans from the financial market to the
taxpayers. The Federal Reserve agreed to take $30 billion of risky
assets. If defaults occur, the Fed will reduce its annual transfer to
the Treasury.

Mr. Frank and Senate Banking Committee Chairman Christopher Dodd are
planning more schemes to move the risk to the taxpayers from those who
made bad decisions, such as buying mortgages that are now in default.
As a result, ordinary citizens will ask themselves: Why should I pay
my mortgage if my neighbors can get theirs reduced? These proposals
have stark long-term consequences. The financial system cannot survive
if the bankers make the profits and the taxpayers take the losses.

The government has a responsibility to prevent systemic crises and
financial collapse. Long ago that job was given to the Federal
Reserve. It serves as lender of last resort to the market. Today, the
Fed should not rescue individual firms, but it must keep the payments
system from failing. To carry out that responsibility, the Fed has
auctioned reserves and exchanged marketable Treasury bills for
illiquid mortgages, and it has succeeded so far. Now, it must stop
responding to calls for lower interest rates.

If the government underwrites all the risks, call it socialism. If it
underwrites only the failures, call it foolishness.

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Mr. Meltzer is a professor of political economy at Carnegie Mellon
University, a visiting scholar at the American Enterprise Institute,
and the author of "A History of the Federal Reserve" (University of
Chicago Press).



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