In a book titled Theory and History, Ludwig von Mises wrote, “Because history is not a useless pastime but a study of the utmost practical importance, people have been eager to falsify historical evidence and to misrepresent the course of events.” In recent history, the champions of regulation and state control of the economy would endeavor to depict the financial events of 2007-2008 as a failure of regulation. At least one historian is worried that we might have “learned” the wrong lessons if we suppose any such thing.
Historian Niall Ferguson of Harvard University says that insufficient regulation may not be at the heart of the financial crisis. Ferguson calls into question Princeton economist Paul Krugman’s assertion that Reagan era deregulation of financial institutions triggered the crisis. “For one thing,” wrote Ferguson in The Great Degeneration, “it is hard to think of a major event in the US crisis — beginning with the failures of Bear Stearns and Lehman Brothers — that could not equally well have happened with Glass-Steagall still in force.”
History teaches that rule of law plus economic freedom makes for prosperity, yet we are supposed to believe that restricting freedom — or eliminating vital aspects of freedom — will somehow prevent financial ills. According to Ferguson, “there is something especially implausible about the story that regulated financial markets were responsible for rapid growth, while deregulation caused crisis.” The fact that heavily regulated markets in the past have created less wealth than free markets under the rule of law must surely count for something. Furthermore, there is no progress without risk, no advances without partial setbacks. And what does the history of capitalism show if not the fact that the advances have far outweighed the setbacks. And if freedom means progress then we must accept the consequences of that progress instead of introducing regulations that will, in the end, choke off progress altogether.
Ludwig von Mises wrote: “To lie about historical facts and to destroy evidence has been in the opinion of hosts of statesmen, diplomats, politicians, and writers a legitimate part of the conduct of public affairs and of writing history. One of the main problems of historical research is to unmask such falsehoods.” Ferguson’s unmasking of falsehood reminds us that spectacular economic progress is not found in eras of complex or heavy-handed financial regulation. The sad truth is that regulation has far more to do with causing crises than deregulation. “The financial crisis that began in 2007 had its origins precisely in over-complex regulation,” wrote Ferguson. “A serious history of the crisis would need to have at least five chapters on its perverse consequences….”
Ferguson wrote up a brief overview of his proposed five chapters on the role of government interference in the financial crisis, which may be summarized as follows: (1) incentives were given to bank executives toward low risk assets; (2) Risk was weighed on ratings given to securities; (3) monetary policy consisted of cutting interest rates at the abrupt fall of asset prices, but not if they rose rapidly (as in the housing bubble); (4) Congress passed legislation that effectively offered home loans to people who would not otherwise have qualified, inflating real estate prices with “unhedged and unidirectional bets on the US housing market”; (5) Chinese currency manipulation effectively and artificially provided the United States with “a vast credit line.”
This analysis not only implicates the United States government in the crisis, but also implicates the Chinese government. The partnership of these two great countries triggered a very real series of market distortions, noted Ferguson. Interference of the market by government, in order to benefit a particular country or political interest group, clearly set the financial crisis in motion. “The only chapter in this history that really fits the ‘blame regulation’ thesis is the non-regulation of the market in derivatives such as credit default swaps,” added Ferguson in an aside. “However, I do not believe this can be seen as a primary cause of the crisis. Banks were the key to the crisis, and banks were regulated.”
Of course, the question for Ferguson is not whether banks should be regulated. “There is in fact no such thing as an unregulated financial market,” wrote Ferguson. Even Adam Smith, the man who cheered the free market, proposed regulations for banks. It is only obvious that rules must exist with regard to the enforcement of debts and the punishment of fraud. Without this, argued Ferguson, “there can be no finance.” In the opinion of someone who values freedom, the problem comes when regulation goes beyond what is required for the enforcement of contracts (which are voluntarily entered into). As Ferguson put it, “I believe excessively complex regulation is the disease of which it pretends to be the cure.” The problem with taking regulation too far, wrote Ferguson, has to do with “a flawed understanding of how financial markets work.”
There is within the financial markets a continuous process akin to “natural selection.” Those who fail must be allowed to fail. But now we have regulators who propose, under government auspices, to interfere with the natural order of things. “There are indeed more than merely superficial resemblances between a financial market and the natural world as Darwin came to understand it,” noted Ferguson. Regulation should exist to safeguard contracts and the rule of law, not to ensure the survival of badly run companies. Such a possibility opens the door to corruption in which the government becomes the silent partner of inefficient businessmen who may operate successfully only by way of political help.
“The rule of law has many enemies,” suggested Ferguson. “One of them is bad law.” And after 2008 the U.S. Congress passed one of the worst laws ever. The Wall Street Reform and Consumer Protection Act of 2010 is what Ferguson calls “a near-perfect example of excessive complexity in regulation.” It is a law which seeks, in its own language, “the comprehensive regulation of financial markets.” And the word “comprehensive” is no joke. The Act creates two regulators where one had previously served. The law has spawned hundreds of new rules and, more significantly, blocks Systematically Important Financial Institutions from “proprietary trading.” It is, in fact, a monster of regulation which compels each regulatory agency to establish “an Office of Minority and Women Inclusion” to ensure “increased participation of minority-owned and women-owned businesses in the programs and contracts of the agency….” (Say good-bye to “natural selection” in the market-place.)
In effect, this supposed “Consumer Protection Act” says that the Treasury Secretary and Federal Deposit Insurance Corporation can take over any failing bank or financial institution if said firm’s collapse might lead to general financial instability. I should like to know how such a law could possibly be constitutional with regard to the Tenth Amendment, which states, “The powers not delegated to the United States by the Constitution, nor prohibited by it to the states, are reserved to the states respectively, or to the people.” Nowhere in the Constitution can I find the seizure of private banks listed among the powers of the federal government. Such a power, if existent at all, might only belong to the States of the Union.
Here regulation and economic stagnation walk hand in hand with the corruption of the supreme law of the United States. After the Wall Street Reform and Consumer Protection Act was passed the president of the American Bankers Association said, “To some degree, it looks like they’re just blowing up everything for the sake of change.” Bankruptcy expert David Skeel characterized the law as “a system of ad hoc interventions by regulators that are divorced from basic rule-of-law constraints.”
With regard to Skeel’s statement, what could be more sinister if today’s financial regulations prove to be a sop to crony capitalism? “Lurking inside every such regulation is the universal law of unintended consequences,” noted Ferguson. And so it is. Yet there are also intended consequences. We know that politicians — as Mises indicated — are not disinterested when it comes to misrepresenting history. Political agendas are always coming into view, with potentially dire consequences for the economy and the financial markets. It may turn out, in fact, that we have learned the wrong lessons from recent financial history. In that case, Professor Ferguson has given us a point of departure from which the right lessons may well be drawn.