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Both government and the marketplace are brilliant human inventions. For too many years we have seen them as conflicting ideas when in fact, they are complementary and neither is the whole solution. Without government we would live without law or order and without the marketplace we would each have to grow our own food, build our own houses and never gain the benefits of doing what we are each best at.  Without government or the marketplace our lives would be difficult, short and brutish.

Both of these human inventions are tools of our society, and just like automobiles or refrigerators, require maintenance, repair and adjustment. Government, without restraint, naturally becomes a dictatorship.  The marketplace, without restraint, naturally becomes a monopoly.  Both then harm our lives in more ways than can be counted. The question is how much and which regulations really serve us best. Total government regulation would paralyze an economy and ultimately destroy it as happened in the USSR. Too little, destroys the marketplace and can cause equal paralysis and destruction as occurred in late 2008.

The key is to use both properly and to keep them in good working order. We have thousands of years of experience with both tools and we know how to use them, but dogma and ideology have tripped us up. [Paul, what do you mean by tools?  I think you mean restraints and regulations, but the way the paragraph read before I shifted it around, tools seems to refer to government and marketplace.]

The financial disasters of the last few years were predictable and, in fact, predicted by economists and historians. The Enron fraud was flagged by the IRS but their warning was ignored by a dogmatic, anti-regulation SEC. Enron wanted to take a tax deduction for its large trading losses without having to show the loss on its reports to shareholders. The IRS agreed the losses were real and deductible. It also notified the SEC that these were not just paper tax losses, but real losses that needed to be disclosed to the public. The SEC did nothing. A broken tool.

The housing bubble was fueled by lending practices that all bankers and economists knew were fueling disaster. If you lend to someone without a down payment and without the ability to repay the loan, you guarantee default on the loan. Nonetheless, the dogma of an unregulated marketplace prevented the Fed, the Treasury and the FDIC from doing their jobs.

The short selling bubble that cratered many of our banks is another example of not using tools we know well. Short selling is essential to any successful economy. It lets a farmer sell his crop before it’s planted so he can buy seed, fertilizer, etc. It also lets stock and bond investors reduce their risk and helps to keep upside speculators in line.

Nonetheless, it can be abused. For years we had an “uptick rule”. This rule provided that if you wanted to sell short a stock that was selling at $100.00, you had to sell at a higher price, say $100.25. A few years ago we dropped this rule. Now speculators could keep selling short at lower and lower prices and create a self-fulfilling rush to the bottom.

We also had a rule that prohibited “naked” short selling. The result of this rule kept the size of the short sales no greater than the size of the actual shares in the market. When we eliminated this rule, speculators were able to overburden the market with short sales many times the size of the actual shares in existence. This overburden allowed them another tool to create a rush to the bottom.

These two rules effectively prevented stampedes and as expected, when we eliminated these rules, the stampedes followed. With the bank shares driven to almost nothing, the banks couldn’t sell new shares to rebuild their capital positions. Next they couldn’t borrow and finally we had to rescue them or our whole economy would have cratered because everyday business people couldn’t finance their inventories or receivables.

There are many other examples of deregulation run amok. The Madoff scandal could not have happened if the SEC had investigated the complaints they received and reviewed the suitability and independence of the auditors.

We need to approach our government and marketplace intelligently and pragmatically. We must use our accumulated experience like good mechanics. The mechanics in this case are the pointy-headed intellectuals we treat with disdain. We need to remember that our Founders were intellectuals. They studied history, read poetry and investigated basic science. They also understood that all their studies and life experiences provided practical tools for a practical world.

We need to:

  1. 1.have meaningful rules that require the regulators, like the SEC, the FDIC, etc. to treat the public as their clients,

  2. 2.create a government function that assures the independence of auditors,

3. enforce time tested lending restraints on the banks, and

4. create a financial oversight board charged with updating the rules to:

a. eliminate those no longer needed,

b. refine existing requirements,

c. propose new ones to deal with new issues, and

  1. d.ensure that the the SEC, FDIC, etc. and outside auditors are in fact independent.

If the porridge is too hot we can’t eat it. If it’s too cold we don’t want to eat. To be useful, the porridge must be just right.


Government v the Market Place