On regulation

As I read 'Predator Nation' by Charles Ferguson, a dilemma has been increasingly bothering my laissez faire self.

It does appear that left unchecked, human greed can run wild. We can perhaps see examples of this in India too, if some of the estimates of politicians' wealth are to be believed.

I am aware that the next few paragraphs are old news to most people who have had even a passing interest in the financial crisis of 2008, but I am trying to build the premise for my dilemma, so please bear with me.

The US financial industry lobbied very hard during the Clinton and George H W Bush years to first remove any regulation on the financial markets and then to actively prevent regulation of OTC Derivative products.

Brooksley Born, chairperson of the Commodities Futures Trading Commission had suggested that complete deregulation of the derivatives market could lead to a future crisis. Larry Summers and Alan Greenspan used all their might to squash Born's initiative. She resigned shortly after.

The Glass-Steagall Act of 1933 had enforced the separation of commercial and investment banking in the wake of the Great Depression. Larry Summers proceeded to push for the passing of the Graham Leach Bliley Act in 1999 which in effect undid the Glass Steagall and allowed Investment Banks to buy commercial banks and home mortgage issuers. That this act was passed after the merger of Citibank and Travelers Group, in violation of the Bank Holding Company Act, caused some to nickname it the Citibank Relief Act.

The rest as they say is history. Investment Banks started investing in Mortgage issuers primarily to ensure that these companies would provide a steady stream of new mortgages to the big banks to bundle and sell as CDOs.

This is where things started going really awry. Since the incentive structures at the investment banks were based purely on short term production, i.e. sales volumes with no penalty for poor future performance, i.e. no clawbacks on commissions paid out, the investment bank traders worked very hard to ensure that they had more product to sell. When the market ran out of credit worthy people to sell home loans to, they started selling home loans to the slightly un-creditworthy customers and then to anybody on the basis of stated income rather than proven income.

Predator Nation alleges that these were not acts of stupidity or naivete, but that people knew exactly where this was going. However, with incentives based on current performance with no thought for future performance, this was economically, the rational thing to do.

I have always seen regulation as a way to protect the current incumbents of any system from new competition. Think Licence Raj that protected the manufacturers of bad products from new entrants. However, we need to perhaps accord a little more respect to the original intention of any regulation; which is to protect the have nots from exploitation by the haves. Clearly, along the way, something is lost in execution as the haves always manage to exploit the system for their own benefit. I have heard a saying among the business community in India; "Jitne kaayde, utne phaayde" (The more the regulation, the more the profit).

My dilemma then, which I am struggling to reconcile; is regulation really the only way to ensure some semblance of equalization of opportunity, to control runaway greed?