Government Regulation Avoidance 101

A Carnegie-Mellon economist compared capitalism to all the other economic systems on the planet and, unlike many of his academic peers, found that it works best. “Capitalism is the only system that adapts to all manner of cultural and institutional differences,” Allan H. Meltzer argues in his book Why Capitalism? “It continues to spread and adapt and will continue to do so for the foreseeable future as long as people value both growth and freedom.”

By way of contrast, “The 20^th century is rife with promised ends that were never realized that turned into a justification for deplorable means,” Meltzer claims of alternatives to capitalism. “Assigning decision-making authority over resource allocation does not eliminate crime, greed, self-dealing, conflict of interest, or corruption.”

“Experience tells us these problems remain, regardless of the system’s form.” On a milder level, increased regulation in the United States rarely achieves the desired effect but does provide new outlets for financial sleight-of-hand.

The current banking crisis provides a textbook example of same. “The Basel Agreement required banks to hold more reserves if they increased risk,” Meltzer notes. “Regulation thus addressed the problem but was overlooked or disregarded.”

“The banks responded to Basel regulation by putting their risky assets in off-balance sheet entities.”  You can see the high hopes that the feds put on this federal fiat in their heralding of it two years ago.

“The U.S. federal banking agencies support the agreement reached at the September 12, 2010, meeting of the G-10 Governors and Heads of Supervision (GHOS),” the Federal Reserve Board proudly announced on September 12, 2010. “This action, in combination with the agreement reached at the July 26, 2010, meeting of GHOS, sets the stage for key regulatory changes to strengthen the capital and liquidity of internationally active banking organizations in the United States and around the world.”

“The U.S. federal banking agencies actively supported the efforts of the GHOS and the Basel Committee on Banking Supervision (Basel Committee) to increase the quality, quantity, and international consistency of capital, to strengthen liquidity standards, to discourage excessive leverage and risk taking, and to reduce procyclicality in regulatory requirements.”  Maybe no one understood what procyclicality was.

“So, in effect, Basel increased risk by inspiring evasion that was nontransparent,” Meltzer explains in Why Capitalism? “Simultaneously, investors were overassured that regulatory oversight existed and could be confidently relied upon, when it could not be.” Meltzer has actually come up with an explanation to explain this phenomenon.

“This followed my first law of regulation,” Meltzer writes in Why Capitalism? “Lawyers and bureaucrats regulate.”

“Markets circumvent regulation.” Where there is a first law, there must be at least one more.

“My second law of regulations says: Regulations are static,” Meltzer writes. “Markets are dynamic.”

“If circumvention does not occur at first, it will occur later. Regulation then often misleads the innocent.”  As it happens, Meltzer inadvertently got to test this theory.

“I was speaking at the Council on Foreign Relations and said that government regulations get circumvented,” Meltzer remembered in an appearance at the Cato Institute on April 24, 2012. “The Council is bankrolled by Wall Street.”

“Someone there said, ‘Who do you think is teaching them how to circumvent? We do.’”

Malcolm A. Kline is the Executive Director of Accuracy in Academia.

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