The subject of regulation has dominated the media and congress over the last couple of weeks and is sure to continue for the next couple of years.  The goal of restructuring the regulatory apparatus of the financial markets from an antiquated system to a modern system has been voiced as one of the main tasks before the new congress.  If we are to move ahead and not backwards it is important to establish ones premises and define ones terms in order to have a compass that will negotiate the troubled waters ahead.  My starting point is to answer the question "what should the role of laws, rules, and regulations be within a free society"?

In a free society, the initiation of force should be outlawed as a method of accomplishing goals.  The initiation of force, which includes theft, coercion, and fraud should either be prevented or punished whenever and wherever possible.  The function of government is to abstain as well from using force to accomplish goals; and it should establish laws, rules, and regulations and a court system that can resolve violations and disputes peacefully.

Force in a free society should be used to defend individual rights and property rights; this by the police domestically against criminals and the armed forces internationally against aggression from abroad.  Laws, rules, and regulations must be set down for all to see and know, and should seek to protect life, liberty, and property.  They should be objective and consistent with freedom.  To the extent they aim to force, manipulate, or coerce, individuals to take actions, or prevent them from taking peaceful actions, they are immoral and counterproductive.

There are two kinds of regulation.  First, are regulations that establish standards and rules of conduct. Stop signs, traffic signals, and traffic laws are examples of protective regulations.  It doesn't matter what color the lights are in a signal as long as once established, they remain the same.  Individuals can have confidence that a red light always means the same thing.  If you were to change the rules of the road every few years and make a red light mean what a green light means you would have chaos.  Once established, protective and objective laws aid society.

The other kind of regulation is coercive regulation.  An example of such regulations were those that prevented individuals from opening a business in their home.  One of Ronald Reagan's first moves to deregulate America was to eliminate those kinds of regulations.  Such regulations did not protect individuals, they prohibited peaceful and productive actions. Those that advocate deregulation usually do so with the intent of allowing more freedom of action such as working from home, and rarely advocate eliminating regulations such as traffic lights.  The whole idea of regulation should be within the context of promoting freedom, establishing order, and promoting enlightenment.

It is important that regulations be consistent with freedom but just as important, is that they be known and fixed over time such as the traffic light.  It is in this way that we can know the "rules of the road".   For example, there are great cultural differences in laws and regulations between nations.  If we travel we need to know what is permitted by governments, what is not, and the penalties for violating the rules.

In America if you steal something and it's your first offense you are likely to get a slap on the hand.  In Iran you will get it cut off.  In America we argue about the right to an abortion.  In China you are put in prison if you have more than one child.  In this country a teenager caught spraying graffiti will likely have to clean it up.  In Shanghai he or she will be whipped in public to an inch of their lives.  Laws, rules, and regulations vary widely from country to country but as long as they are objective and  we know what the penalty is, we can live with them, good, bad, rational, or not.

So, it is not as much a question of regulation, per se, but of knowing the regulations.  I would argue that regulations that are both objective and consistent with freedom, represent good regulatory policy.   When it comes to economic regulation it is crucially important to establish only those regulations compatible with free markets and those that help promote commerce, not impede it.   Regulations that enhances freedom, safety, order, and experimentation are pro progress.  Regulations that prevent innovation, experimentation and the natural market process from working are anti progress.

Personally, in the field of economics, I draw the line at theft and fraud.  Any actions that steal from individuals or defrauds them, including violating contracts, should be against the law and regulated at least on some level.  Other rules that enhance transparency or aid in the markets function of price discovery are fine, as long as they do not violate other rights such as the right to privacy.  In the years throughout the 17th, 18th, and 19th centuries the term "buyer beware" was an everyday motto.  It was the ultimate regulation.  Individual responsibility was the first, and many times the only, line of defense.  In the last analyst, it will always be so.

Down through history there has always been mania's, panics, crises, and booms and busts, all of which led to victims.  Freedom does not guarantee rationality  During Holland's tulip craze an entire society went mad.  Tulips went from penny's a bulb to ten's of thousand's of dollars.  What regulation would have stopped that stampede?  Even under the Gold Standard there were a dozen panics and recessions even though money and credit was tightly disciplined.  There will always be another boom and another bust.  Regulation cannot prevent them.  All that rules and regulations can do is to try and prevent theft and fraud, further the attempt to get good information which help to make intelligent decisions, and attempt to bring order to complicated social structures.

Today, everyone is looking for scapegoats.  They are looking for reasons and lessons to be learned to avoid such incidents in the future.  Well, that is impossible.  The very nature of panics and crises are that they always change.  They are always new and surprising.  If they weren't, there would not be panics -- they would be discounted by the market before becoming much of a problem.  They blind side a society.  That is their nature.  To be sure, government policy mistakes can lead to crises, but the private marketplace has its own rich history of crises without governments "help".

The Idea that a regulator could have prevented the present crisis is absurd.  Certain regulations could have been in place that might have made it less severe or pervasive, but it has spanned the entire globe.  We live in an international economy today.  Each nation has their own list of crises.  Many are vastly different from one another.  Some are the result of their own real estate boom and bust.  Others have more to do with the rise and fall of emerging markets. Still others are the result of the fall in oil and other commodities. Yet, all nations are experiencing economic and monetary turmoil.  What regulator, what agency, what government can claim to have prevented all of these nations from reaching this point -- all with different monetary, economic, and regulatory systems?

There is no doubt that it is time to add new, more pertinent regulations that aid our economy.  There is also no doubt that we should do away with much of the old regulatory bureaucracies of the past.  It is imperative that in this transition we not grant the grabbing of power for powers sake to the government.  Laws on the books already exist to punish fraud and theft.  Contractual laws already exist to punish those lenders or borrowers that lied, cheated, or performed acts of deceit.  Few new regulations need to be added.  But that will not dissuade the army of bureaucrats that await new regulatory authority from wanting to form huge new agencies to oversee everyone and anything they can.

I've never understood why sensible academic types believe that individuals in government would be somehow better regulators than individuals in the private sector. The private sector always does things more efficiently and less expensively than government. A traffic light works whether installed and maintained by government or a private business.  Yet, it is government that usually ends up being the recipient of such contracts.

In the coming government orgy of investigative committees and studies that will eventually recommend a new regulatory infrastructure, let's hope that the structure will aide freedom, not quell it; promote productivity and commerce, not stifle it; and encourage experimentation and innovation, not discourage it.

Paul Nathan
Paulnathan.biz