The Impulse to “Regulate More” is Back
Over at Cafe Hayek, Russ Roberts takes on the impulse to regulate more, a topic I have recently addressed. Looking at the recent collapse of MF Global, the asset manager headed by failed New Jersey governor and crony capitalist extraordinaire Jon Corzine, affords an opportunity to consider how best to manage risk.
Roberts’ basic point is a sound one. We can talk until the cows come home about how we would manage risk from a prudential regulatory standpoint, but the bare fact remains that our knowledge is now, and will always be, imperfect. Naturally. If it were perfect, profit from speculation would be impossible in the first place.
So what then actually does manage risk? According to Roberts, losing money is a pretty good start.
There are two ways to restrain imprudent leverage. The first just got imposed on Corzine. His creditors lost most or all of their money. They’ve learned a lesson. If they were overly optimistic about a bailout, they have adjusted their expectations somewhat for the next time. If they were just overly greedy or optimistic or naive they’ve had some prudence and sense knocked into them in a very expensive fashion. If we can avoid the temptation to bail out firms leverage will shrink as lenders learn its risks or at least lose their money. Both make it harder to keep leverage high in the future.
What do we know for sure? Simply that a group of people has lost a large amount of money and probably should have made better decisions. That’s about it.
What do we not know? What those better decisions would have looked like without foreknowledge, or what they might look like in the future. Indeed, what looks like a poor decision in hindsight may, without any logical contradiction, be the best decision under a different set of circumstances.
Ultimately, we do not know these things, and we cannot know these things a priori. Attempts at “better” regulation (read: more) or “smarter” regulation (read: more), or “targeted” regulation (read: more) will not work. This is true, not because of what we have learned, but because of what we can never learn.
If we truly want a regulated market, we need a market in which people gain and lose money based on their decisions. In other words, we need people to be responsible for their actions. Losing money is necessary.
Roberts continues with another proposed “solution” to the problem of leverage:
The alternative is capital regulation which Cohan and Lewis advocate. We’ve tried that already. Count along with me: One Basel, Two Basel, Three Basel.
It never ceases to surprise me at the extent to which people place blind faith in regulations. It is assumed that can and will work, they are implemented, they fail spectacularly, and the immediate impulse is to regulate more. Simply mind-boggling.
There is no “right” regulation. There is nothing that can be done to prevent this sort of thing in the future, because gains and losses are a part of life. There should be nothing done to prevent these types of decisions in the future, because we cannot know what circumstances the future will bring.
Regulating more is simply inviting more failure.