True, but have you ever been driving on an icy road and seen people going the speed limit, 55 miles per hour?
The psychology people seem to have is to believe that if the government regulates it, then anything that falls under the regulation requires no independent thought.
On the icy road, the safe speed maximum is probably about 30 mph, but many accidents are caused by people going the posted limit, as people seem to trust the wise planner above their own ability to judge.
Similarly, people assume that a firm that is regulated by the SEC and backed buy the FDIC is going to be a safe place to put money, which is not always true.
I agree with your last statement, but note that 1) the SEC required insufficient reserves, and 2) because the government set the reserve limits, there is the implication that it ought to bail out the firms that were "just following the rules".
Hence the view of firms being "too big to fail" comes from the idea that regulation is perfect and if only it's followed then everything will be fine.
In a better, more libertarian world, banking crises would result in some failures, and once-burned investors would look carefully at what reserves actually mean, look sceptically at rating-weighted reserve requirements, and expect that if things go wrong there will not be a bailout.
This would help put money into firms that actually know how to act in a trustworthy, sound way, not just the firms that are able to successfully lobby the SEC, the way Madoff's did.
The problem that I have with your examples is that it requires all actors, including consumers, to have nearly perfect information access, and to be able to act on that.
In the car example, I think we have a difference of philosophy. I think that regardless of the posted speed limit, some people will not exercise the proper judgement because they have evaluated the conditions differently.
In the example of reserve funds, imagine a world with similar information asymmetry to today. Banks are semi-transparent, and deposits are backed to some extent by the FDIC. However, the SEC takes less of an active regulatory role, the result of which is that some unscrupulous banks have started offering insanely high interest rates based on dangerous fractional reserves. People will likely flock to those banks, especially given that the FDIC is backing their investments... and then the whole thing collapses.
One solution is to get rid of the moral hazard inherent in the FDIC, and make it clear that the only way to hold your money safely is in cash, in your home. But one of the signs of civilization is increased specialization of labor; I should not have to do the job of banker and regulator all rolled into one, just to have a place to keep my money. Worse, it's not even clear that this is possible, because of inherent information asymmetry.
We can argue about whether an adequate ad-hoc bank insurance solution would arise, however, I'm not sure that such an invention would increase efficiency in the market.
As for regulation, there doesn't really seem to be any real alternative, unless the direct consequences for the operators of failed financial institutions became much more dire. And criminalizing poor business decisions doesn't seem very Libertarian at all.
If I walk into a bank and consider depositing my hard earned cash, perhaps I'd demand enough transparency to determine whether to trust that entity with my cash, in exactly the same way that I must trust Amazon when I place an order online, etc.
Information will always be imperfect, but it's in both parties' interest to increase transparency. It's barely even a coordination problem in today's world.
As a note to your remark about my speed limit explanation, why is it then that on an extremely icy road people go exactly the posted speed limit rather than, say, 90 miles per hour? Clearly they are taking the sign literally and at face value.
So one regulatory approach that would be an improvement over the current one might be to require a reserves "rating" to be published, much like the smoking causes cancer warning. Perhaps right under the bank's logo it would have to say "This bank has a reserve score of 71 (moderately risky)".
And yes, there would be room for 3rd party ratings to be applied to bank solvency as well. I'm not sure what the best approach would be, but consider that most securities regulations were made in the 20s before the information revolution (ironically, the "Financial Services Modernization Act" removed a few of the depression-era regs that were actually smart and prevented moral hazard and conflict of interest). Surely there would be a lot of clever approaches. One idea that intrigues me is that the government could offer its rating, but banks would be required to obtain several. I'd love to see someone like Michael Moore create his own such agency and use his genius to publicize it.
Analogously, consider the FDA drug approval process. Everyone knows that the FDA process is flawed, as people are routinely killed by side-effects of drugs. So why not have several ratings: One from a consortium of insurers, one from the AMA, and one from the FDA -- each group has a slightly different downside risk (and upside) to approving a dangerous drug or failing to approve a safe one in a timely fashion. Why not have a grid of 3 checkboxes on every drug. The absence of an AMA approval might be a warning sign to some, but not others.
If you think this idea is silly, consider what happens when the FDA gets it wrong and lots of people die because of a drug... exactly nothing but a too-late knee-jerk reaction. Usually the drug is immediately pulled even if it has other valid uses, etc. One perverse example: many doctors knew the dangers of Vioxx well before the scandal (the same risk exists in lesser form with all such drugs, even Ibuprofen) and good ones didn't use it on patients at risk for bleeding without great caution. Yet it took a few years and then bang, it's gone from shelves even though there are a few essentially identical drugs that stayed on the market and do still occasionally kill people when used without caution by docs.
I'm not claiming to have the whole idea of optimal regulation for the 21st century figured out, but I'm just brainstorming. Surely there would be a lot of great and clever ideas. The current, one-size-fits-all approach leads to massive and often ineffectual regulatory apparatus.
Why shouldn't coming up with ad-hoc regulatory / information-dissemination / transparency-reducing systems be something that startups do? Why not in the case of medical trials have data published to the web so that people can make mash-ups with all the data that is being considered by regulators? A few weeks ago the SEC approved a plan to put financials in XML format, but it's all very primitive and is unlikely to be all that useful, but the core idea of transparency through an API is a good one, I think.
The role of the "regulator" of the future, I think, is to design a good API spec (metaphorically and literally) and possibly make a list of all of the watchdog groups offering analysis. State and federal governments could fund their own watchdog groups too -- maybe I notice that Wyoming's prescription-drug watchdog group has been right a bunch of times in a row, so I begin trusting it more than the one in my own state. Maybe I decide to trust Michael Moore's group or Paul Graham's. Over time the best would rise to the top and every mistake would give new groups a chance to enter the limelight -- maybe a YC startup was the only one not to approve Vioxx, for example.
Toward the libertarian goal of efficient, small government, we should be focusing on regulation that increases transparency and also increases the number of entities that can act as private watchdogs. It's exceptionally telling that the SEC received repeated complaints about Madoff's fund from various sources and still did nothing. One might argue that the SEC is understaffed, but it found the staff to shut down prosper.com, a startup that was making humanity better off, on a technicality, not even on any remote accusation of fraud. More likely, prosper.com competed with the established finance powerhouses, so the SEC was probably just acting to keep competition out of the industry.
Most of what all of the regulatory agencies do is coordinate information, and if the modern world (and the internets) have done one thing, it's make such problems extremely easy and inexpensive to solve. My basic argument is that the antiquated structures create a false sense of security and get in the way, as well as soak up tons of industry lobbying dollars to the point where industries tend to become highly regulated and highly protected, the two biggest characteristics of libertarian dystopia. The military industrial complex and now the financial and auto industries are that sort of thing. Big agriculture is too, as well as many others.
> The psychology people seem to have is to believe that if
the government regulates it, then anything that falls under
the regulation requires no independent thought.
But according to your own line of thought, shouldn't people be fully responsible for their own conduct, regardless of the surrounding circumstances? If so, how is lack of governement regulation going to help people determine the correct speed to go at on icy roads?
My point is just that a rational person generally uses his/her cognitive faculties to assess risk, but that regulation often leads to short-circuiting of critical thought.
The heuristic becomes one of people believing that the government must have already looked out for all dangerous possibilities, so anything that is legal is safe.
I don't feel the need to look down my nose and say "people should be individually responsible" because I don't consider that productive. I think people are naturally responsible enough to look out for their own interests, unless they are misled.
One example: investors in Madoff's hedge fund were misled by the SEC stamp of approval on that fund. Don't you think that normal scepticism about the returns ought to have led to some scrutiny?
The psychology people seem to have is to believe that if the government regulates it, then anything that falls under the regulation requires no independent thought.
On the icy road, the safe speed maximum is probably about 30 mph, but many accidents are caused by people going the posted limit, as people seem to trust the wise planner above their own ability to judge.
Similarly, people assume that a firm that is regulated by the SEC and backed buy the FDIC is going to be a safe place to put money, which is not always true.
I agree with your last statement, but note that 1) the SEC required insufficient reserves, and 2) because the government set the reserve limits, there is the implication that it ought to bail out the firms that were "just following the rules".
Hence the view of firms being "too big to fail" comes from the idea that regulation is perfect and if only it's followed then everything will be fine.
In a better, more libertarian world, banking crises would result in some failures, and once-burned investors would look carefully at what reserves actually mean, look sceptically at rating-weighted reserve requirements, and expect that if things go wrong there will not be a bailout.
This would help put money into firms that actually know how to act in a trustworthy, sound way, not just the firms that are able to successfully lobby the SEC, the way Madoff's did.