No Matter How Big, Government Regulatory Agencies Can Never Be “Big Enough”

by Michael Owen

Recently, I was watching the Fox Business coverage of Harry Markopolos' congressional testimony regarding the Madoff pyramid scheme scandal. If you don't know the story, Markopolos (among many other whistleblowers) had warned the SEC for approaching a decade that Madoff was a fraud. Markopolos (among others) had mounted a private investigation, and come up with 29 separate "red flags", which he had delivered to the SEC on a silver platter through multiple reports. The SEC never did anything; the Madoff scheme ultimately finally came apart when Madoff himself announced it, as "investors" (pronounced "marks") were trying to get access to their money as the recession deepened.

The response of the pundit that Fox Business had brought on to talk about the coverage was typical. What was his recommendation in the face of this colossal failure of government regulation? Why, more of the same, of course. The problem, you see, is that the SEC doesn't consume enough resources, it doesn't have enough "investigators". Even though Markopolos only had a team of three, count 'em, three investigators to uncover it, and others discovered it simply by reading the Wall Street Journal, the SEC apparently doesn’t have enough investigative resources.

This is the standard response to the inevitable failure of all government programs, they are "chronically underfunded," they never have enough resources to do a good job, etc. This is endemic; it is symptomatic of the systemic flaw in the government model. We are told that the market (i.e. the people) are incapable of taking responsibility for X (their own protection, the safety of the food or drugs they ingest, the soundness of their investments, etc). The government then creates a bureaucracy with the stated goal of taking responsibility for X. The more gullible segments of the public then becomes more lax; they don't have to worry about providing for their own security, that's what the police are for. They don't have to worry about the soundness of their investments, that's what the SEC is for.

The problem, of course, is that indeed the government can never have enough resources to take responsibility for all of the people that it has tricked into behaving irresponsibly. "Regulation" in a market with hundreds of millions of producers and hundreds of millions of consumers is provided for by the actions of the market participants themselves in their patterns of buying and abstention from buying, in the words of Mises. The simple heuristic of "buyer beware," the true source of market regulation, is destroyed by the pervasive myth of distant government bureaucracies as omnipotent regulators of human behavior. The bureaucracies are, as a matter of physical reality, devoid of the specific knowledge required for correct "regulatory" decisions, and the "services" that they provide have no market prices, hence there can be no possibility of rationally allocating resources to produce these "regulatory goods" efficiently.

It is a matter of economic law that regulatory agencies such as the SEC can never accomplish their stated tasks, in this case, (among others) to regulate the issuance and exchange of securities from all publicly traded firms in the United States. Such a task is in fact gargantuan; there are thousands of such companies in the US. The market for regulation of the securities-related behavior of such companies is titanic. There is simply no possible way that a single monopoly firm can efficiently have 100% market share in this market. It is certainly true that as companies grow, they can benefit from economies of scale. But it is equally true that eventually economies of scale succumb to diseconomies of scale, most importantly internal bureaucratization, internal calculation problems, etc.

In a free market, the market for "regulation" of securities and exchanges would be filled with numerous firms, because there is a large amount of profit to be made by identifying which firms have above-board practices and which ones don't. I.e. there would be several competing ratings agencies. It would be in the interest of those firms that wanted to raise public capital to play ball with these firms and keep everything above board. Companies would do competitive research on their competitors to sus out improper behavior.

In fact, all of this occurs right now, and is the real source of regulation of most market participants. Government bureaucracies like the SEC claim credit for the spontaneous order produced by markets, when they are really the source of disorder, instability, and corruption.

The government bureaucracy becomes a single point of corruption. It is subject to capture by special interest groups; in the case of regulatory agencies, by the large businesses they are supposed to be "regulating" (for example, the SEC is little more than the PR arm of the securities industry; the FDA is little more than a cudgel for large companies to protect their markets from competition). Big industrial players very often write the very regulations that purport to regulate them, and there is a revolving employment door between these firms and the regulatory agencies; the same people shift seamlessly from private employment in the regulated industry, into the regulating agencies as regulators, and back out again into the lobbying arms for the same companies, back and forth, back and forth.

This is aside from the fact that, as pointed out by historians like Gabriel Kolko and Murray Rothbard, it has almost always been the big businesses who have lobbied for the creation of the regulatory agencies in the first place. Rothbard points out that when Congress passes, for example, a tariff on foreign steel, we are unsurprised to learn that such a measure was invariably lobbied for by domestic steel producers, but that when congress creates the Federal Reserve System it must be the stuff of "conspiracy theories" to point out that the large banking interests that the Federal Reserve was stated to "regulate" were actually behind the agitation for its creation, and in fact wrote the Federal Reserve Act, with the explicit goal of creating the banking cartel they could not maintain in the free market.

Market regulation is currently operating with a vengeance against this corrupt and destabilizing banking cartel. But what does government do? Does it allow the market to wipe out these inefficient, corrupt, and in fact fraudulent institutions so that we can start over on a sound footing? Of course not. That would be too damaging to politically connected special interest groups (i.e. bankers). So literally trillions of dollars of real wealth will be plundered from politically-irrelevant people (the public and foreign holders of US dollars and debt) and transferred to these special interest groups, in an effort to maintain the status quo.

Market regulation is attempting to wipe out the inefficient auto companies and their bloodsucking unions, but government will keep their corpses alive with bi-monthly infusions of billions of taxpayer dollars.

However, I am still optimistic. Market forces are inexorable. Government attempts to overcome the laws of economics the way that someone attempting to overcome the law of gravity might start throwing more and more things into the air. Eventually the juggler will be overwhelmed. Eventually market forces will wash away the corruption, incompetence, the economic irrationality. The market moves faster and faster, while government bureaucracies grow larger and larger and hence more and more ponderous and inflexible. The market will wash them away like raging, rising rivers wash away shoddily built government levies.

Michael Owen is a computational fluid dynamics engineer, filthy anarchist, recovering astrophysicist and armchair economist.