Imagine an American senator nearly a century ago reacting to the introduction of motorized agricultural equipment, which undoubtedly reduced the need for people to live on the family farm as they had for centuries, by declaring, “Innovation cannot be allowed to undermine enduring values.”
Picture a congressman protesting with that same sentence against the success of Henry Ford’s Model T because technological improvement posed a risk to a buggy whip business in his district.
Consider a state functionary shackling creative, beneficial, and popular technologies like Uber and Lyft with rules such as “you cannot take a rider to or from any airport in California” because of the apparently “enduring value” of a high-price low-quality taxi oligopoly.
In addition to the fact that few people have less experience with things they influence than politicians and bureaucrats, they are also a fundamentally “conservative” force — in the worst sense of that word. Namely, they reflexively oppose innovation and change, in part because they don’t understand it and in part because they fear anything that may alter their current politically beneficial positions of oversight and importance in which they can extract maximum campaign contributions from the regulated.
Politicians and the unaccountable bureaucracies they spawn regulate with great gusto, without fail insisting that their impact should be judged by claimed good intentions rather than by actual effects on people’s lives, the economy, and other things that matter in a way a politician’s or bureaucrat’s career doesn’t.
When regulators regulate, the scale and importance of negative unintended consequences is proportional to the importance of the behavior or industry being regulated.
Consider, for example, the explosion of various political groups whose only purpose — one they pursue fairly well — is to get around the unconstitutional and ill-considered McCain-Feingold Campaign Finance Reform law. If you hate PACs and 501(c)s and 527s and the plague of robo-callers and TV ads from groups you’ve never heard of (and wish you never heard from), you can blame politicians.
McCain and friends, in a desire to protect themselves against political challengers, claimed to want to safeguard elections. Instead they unleashed the ridiculous Rube Goldberg campaign finance system we have today. Their mindset was like that of someone throwing a rock into a river and expecting the water simply to stop flowing. So many politicians, so little gray matter.
Consider the unintended but fully predictable consequences of everything from prohibition (whether formerly of alcohol or currently of marijuana) to too-cheap-and-too-available college loans to Dodd-Frank to Obamacare. In case after case, the negative consequences are clearly or arguably in excess of any suggested or promised benefit.
And so it is that we should be afraid — very afraid —when the U.S. Senate investigates the impact of computerized and high-speed trading on financial markets. The relevant subcommittee’s chairman, Sen. Carl “target the Tea Party” Levin (D-MI), released a statement focusing on conflicts of interest and loss of investor confidence, both of which are important (separate from the question of the involvement of politicians). But his suggestion that “Innovation cannot be allowed to undermine enduring values” is a concept so misguided and potentially harmful that it bears scornful repetition.
Tuesday’s hearing focused on a financial market practice known as “payment for order flow” in which exchanges pay brokerage firms (or other market participants) to send orders to those exchanges. Typically, an exchange will pay for an order that is not immediately executed but rather rests on the “order book,” thereby “adding liquidity” to the marketplace. Orders that come into the market to “remove liquidity,” by trading against those resting orders, such as selling at the existing bid or buying at the existing offer, pay for that privilege.
Such payment is a complicated issue that can create obvious conflicts of interest yet has not been demonstrated to be harmful to investors. The complexity of the subject — which is to say its fundamental unsuitability to be regulated by politicians — is suggested by misunderstandings even in the financial press, such as the Wall Street Journal’s unhelpful “Critics said the payments…typically aren't passed on to investors…”
But even a high-school economics student would recognize that payment for order flow — which, for context, amounted to $236 million last year for brokerage firm TD Ameritrade — must be passed on to investors as long as the brokerage market is competitive. The form in which the fees are passed on is in lower commissions or other fees for investing and trading at those firms. At Ameritrade, for example, you can trade an unlimited quantity of shares (in a single order) for $9.99. Fidelity is even cheaper.
As the great French political economist Frederic Bastiat noted, the difference between a good and bad economist (and similarly of a good and bad politician) is the ability to “take account both of the effects which are seen, and also of those which it is necessary to foresee.”
Lest you think this is a merely academic point, Bastiat makes plain why it matters. Again, imagine the word “politician” substituted for “economist”:
Now this difference is enormous, for it almost always happens that when the immediate consequence [of a government policy] is favorable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, at the risk of a small present evil.
One wonders whom Carl Levin expects to benefit as he stumbles blindly down this regulatory path, pushed by the outcry of a few sore losers glomming on to fallacious conclusions made by author Michael Lewis and know-just-enough-to-be-dangerous journalists, muckrakers, rent-seekers, and politicians desperate to change the subject away from how they’re actually doing their jobs.
There may be, at least as long as we’re not living in my libertarian utopia, a nearly legitimate government function in ensuring basic market stability, that disruptions in trading or in financial intermediary functioning are unlikely to cause our entire economy to seize up. But it must be emphasized that during the 2008 collapse, the unregulated parts of finance (such as credit default swaps) did much better than the regulated parts (such as mortgages and banking). Much of the collapse was caused by government’s unpredictability (engineering a bailout of Bear Stearns and then allowing the failure of Lehman Brothers) and by truly stupid regulation — in particular requiring mark-to-market accounting for debt instruments with little or no impediment to their cash flow and likely to be held to maturity, creating a vicious cycle of panic selling and balance sheet destruction.
Even today, regulation and fear of regulators are dissuading banks from while simultaneously discouraging entrepreneurs from starting or expanding businesses. (Hey, at least the lack of interest in doing business is mutual, right?)
It is almost trite at this point, but consider the difference in price, quality, and consumer satisfaction between health insurance and car or homeowners insurance. The former is overpriced, uncompetitive, and terrible to deal with. The latter are, let’s say, tolerable even if not our favorite things to think about. That is because and not in spite of, health insurance being the most regulated insurance market in America. Regulation has caused them to live up to the motto we used to attribute to “the Phone Company” a few decades ago: “We don’t care because we don’t have to.”
Very basic structural reinforcements are one thing. But crushing competition is another thing entirely. There are already discussions underway about requiring firms that have the fastest computers to be slowed down. An analogy to weighting (“handicapping”) race horses to give them similar chances of winning, or to requiring Ferraris to drive the same speed as Hyundais, understates the significance, immorality, and economic stupidity of such policies.
Transparency is a good thing. Conflicts of interest should be disclosed. And investor confidence is important. (It is unfortunate that the main attacks on that confidence come from self-serving writers, reporters, and politicians including one named Carl “Don’t I look wise in my glasses?” Levin.)
But again, who is being harmed by computerized trading or payment for order flow in an environment where markets are not allowed to trade through the best national bid or offer? Or more specifically, who is being harmed in a way which involves fraud and therefore requires the dead hand of Carl “can’t retire soon enough” Levin and the SEC (where people who can’t make it on Wall Street go to get their revenge, and where the few really good employees leave to help Wall Street defend against them).
The evolution of stock market trading, including exceptionally narrow bid-ask spreads and low commissions, are incontrovertibly beneficial to “small” investors. And as for large institutions managing hundreds of millions or hundreds of billions of dollars (the Vanguard Group has more than $2.5 trillion in assets), they know far better how to defend themselves, or play their own “games” within the market structure, than any politician ever will. The idea that mutual funds, pension funds, sovereign wealth funds, and insurance companies need the helping hand of Carl Levin to hamper innovation and competition because of some ill-defined “enduring value” is a recipe for financial disaster and a certain path to larger government, less efficient markets, and a happy talking point for clueless politicians who hope you won’t ever actually notice what they’ve done to you — and that if you do notice, you’ll look to even more government for the answer.
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