Over at The Big Picture blog yesterday, host Barry Ritholtz had a guest author, Bill Black, contribute a piece that blamed the “anti-regulators” for the housing and financial crisis, The Anti-regulators are the Job KillersMr. Black is an associate professor of economics and law at the University of Missouri, Kansas City.  The basic premise of the piece is revealed in the title–Mr. Black believes that people opposed to regulation are responsible for all the jobs lost as a result of the housing market implosion and financial system near-collapse that was itself due to poorly-regulated housing and financial markets. 

Well, it turns out the President Obama, like Mr. Black’s anti-regulators, understands that undue regulatory constraints can impair job creation and economic expansion.  In a piece running in today’s Wall Street Journal, Obama explains that regulations don’t come without costs, and that he is initiating a review of federal government regulations to ascertain in individual cases whether the costs of regulation are exceeded by the anticipated benefits.  Here’s the President:

Over the past two years, the goal of my administration has been to strike the right balance. And today, I am signing an executive order that makes clear that this is the operating principle of our government.

This order requires that federal agencies ensure that regulations protect our safety, health and environment while promoting economic growth. And it orders a government-wide review of the rules already on the books to remove outdated regulations that stifle job creation and make our economy less competitive. It’s a review that will help bring order to regulations that have become a patchwork of overlapping rules, the result of tinkering by administrations and legislators of both parties and the influence of special interests in Washington over decades.

This all sounds well and good.  The benefits of any rule/regulation should always be weighed against its costs.  If the point of rule-making is to enhance the aggregate welfare, then it is obviously the case that rules should do just that or be discarded. 

But here’s the problem.  Contrary to the ideas of either free-market libertarians or regulation-happy liberals, rules and regulations are generally directed at one and only one aim–to enhance the welfare of existing companies relative to potential competitors.   Regulatory capture is a short-hand way of saying that rules and regulations are ultimately written to protect existing entities in an industry by the existing entities.   Rules and regulations are rarely written, and virtually never enforced, to protect consumers of the industry’s products, except when doing so will also enhance the ability of industry competitors to ward off potential newcomers.   The FDA’s approval process for new drugs comes to mind as a mostly nominal consumer protection that actually operates as more of a big pharma protection device, ensuring that vast amounts of capital must be accumulated before cracking the market for prescription drugs. 

Rules and regulations are derived from enabling statutes, which are themselves derived from the political marketplace, which is itself a derivative of the actual marketplace.  Thus rules and regulations are second derivatives of the economic forces at play in the marketplace.  They have been distilled in the political theater to arrive back at the marketplace from whence they arose.  Given the political forces at play in their distillation, it is little wonder that they often make little sense by the time they make it back.  It is the first derivative, the political marketplace, where industry insiders have the most influence and are best able to “capture” the regulators.  The reason is simple.  Any economic/political organization comprised of highly-specialized entities, as each market these days is, will necessarily listen to the market participants (they are the experts) when formulating laws affecting the market, and the entity being regulated will necessarily have the greatest interest in having its voice heard by the organization with regulatory power.  It’s not as if there’s some great conspiracy afoot when a job at the SEC is often preceded by a job at an investment bank, or vice versa.  It’s simply that the regulators and the regulated have a vested, and often congruent, interest in regulatory outcomes.

What is conspiratorial to me is how politicians, particularly on the left, and in the face of massive evidence to the contrary, believe in the efficacy of regulation to achieve government ends.  Do they not understand the political process, or is it perhaps that they understand it all too well?  If you know (and you must know if you have considered the matter at all), that regulations more often than not operate to impede rather than enhance government imperatives, why then do you still sell regulations as a panacea to all that ails markets?  Regulations are second derivatives to market forces.  A better means of regulating markets is to create markets that effectively regulate themselves, by providing a system that severely punishes and weeds out bad actors.   Provide a marketplace where individual actors can no longer hide behind a corporate veil of immunity and you’ll have all the regulation you need.  Yet in that regard, all the financial industry regulations in the world won’t be effective at saving us from the next financial calamity.  The major financial industry players now know that no matter what they do, the government will not only not prosecute them for their misdeeds, it will actually reward them with a life-line to escape from the consequences of their folly. 

So, though Obama’s initiative sounds like a good idea, it will likely have little impact on the actual workings of markets and industries.  In so far as it reflects a view that all we need is something like an IBM’er in a television commercial intoning that he’s gonna save the world by making it “smarter”, it will simply delude us into thinking rules and regulations carry enough power to overcome innate market forces.  They don’t.  Design stupid markets and industries that punish bad actors with failure and you’ll have done all you can to protect the public and ensure the costs of regulation don’t exceed their benefits.