This week Treasury Secretary Tim Geithner outlined his proposed new regulations on the financial industry. Pundits on the left argue that greater regulation of the financial industry are needed in order to prevent additional failures in the industry. Pundits on the right however argue that the proposed regulations constitute a nationalization of the financial industry. In order to determine who may be right, a general understanding of the proper role of regulation by the government in the economy is necessary.
The role of government in the economy is that of a referee. Some referees have a laze fare approach to officiating a game allowing the players to just play. Fans on the side of the team behind in the game will usually vocalize the fact that the referee is not making calls against the other team and use the official’s lack of calls as an excuse for the fact that their team is loosing. Other officials, desiring to have total control over the game, will call every little foul they see and even some that do not exist. Fans of the trailing team in these games will argue that their team is loosing because the official is not letting their team play the game. The best-officiated games are those where the presence of the officials in the game is barely noticeable.
The proper level of governmental regulation is when the government’s presence in the economy is barely noticeable. This occurs when businesses and individuals feel freedom to conduct business in the way they desire but also have a sense of security knowing that if they are wronged, the government will step in to prosecute those who broke the law and caused them harm.
As an example of good regulation we need to look at the FDIC. The role of the FDIC is to insure the deposits of individuals and businesses in banks. Banks pay the premiums to the FDIC so this is nothing more than an insurance policy on the deposits of individuals and businesses at the bank. At present, these deposits are insured for up to $250,000. This constitutes a good regulation because it gives depositors a sense of security knowing that their money is safe without limiting what they can do with the money they have on deposit.
The Fannie Mae and Freddie Mac fiasco is an example of bad regulation. Lenders were provided a false sense of security leading them to write risky loans. In fact, governmental regulations required banks to issue these loans with the goal of making it possible for every American to buy a home irregardless of whether they could afford it or not. This regulation was not funded by premiums like the FDIC but was based on the assumption that property values would always increase and that lenders would always be able to liquidate the asset being held as collateral and recover their losses. However, there is no assurance that property values will always increase and as we have seen, they can actually decrease in value. When this decrease in value occurred, Fannie Mae and Freddie Mac lacked funding to make good on their promises, leading to the failure of many financial institutions.
It is bad regulation when the purpose is not to insure the safety and security of the general public. The FDIC regulations were implemented during the great depression when depositors at banks were losing their life savings due to massive bank failures. The regulations imposed on mortgage lenders were not to insure the security of the general public since people who did not own homes would have the opportunity to rent or if they were in poverty move into government housing until they could afford a home. The purpose of these regulations was only political in nature, designed to garner votes by politicians. The regulators overstepped their bounds and actually created a situation that does threaten the financial security of the general public.
Some regulation is always necessary in order to promote an orderly society.
The Declaration of Independence states that the government’s role is to promote life, liberty, and the pursuit of happiness in other words, to promote the safety and security of the general public. Regulations that accomplish this are good regulations but regulations solely implemented for a political reason are not good and can actually threaten the safety and security of the general public they were designed to protect.
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