Libertarians and free-market proponents get a really bad rap in the economic sector these days. The argument is almost always the same – the financial disaster of this decade is primarily attributable to the greed, dishonesty, and poor ethics of bank owners, CEOs, and “Wall Street” (whatever that means), and the way to prevent this in the future is to increase regulation and oversight on those institutions and people. Free-market proponents are almost seen as cheerleaders for the greed, and dishonesty. Rejection of the solution of increased regulation is seen by its proponents as approval for unethical behavior.

Let’s be clear here. No one disputes that the problems are attributable primarily to greed and dishonesty. No one disputes that almighty profits often lead to unethical behavior. No one disputes that we should have laws enforcing basic honesty and important ethical principles. Those are the hallmarks of a sound society. So with all the niceness I can muster – stop treating free-market proponents like advocates for greed and dishonesty. Seriously, just stop it! Look deeper into the issues before you blast that viewpoint away. And if you hold the opposing viewpoint, that’s fine, but use cogent arguments to defend your view.
:: end soapbox ::

So what is the viewpoint of libertarians (well, at least this libertarian)? The problem with proponents of increased regulation as a means to curb bad behavior is that they rarely consider and/or are unable to predict the associated costs of the regulation.

I’d like to give an example of what I mean. Let’s look at the Sarbanes-Oxley (SOX) Act of 2002. This piece of legislation (proposed by a Dem and GOP together) was a response to the accounting scandals that rocked the early part of this millenium. The problem was that the auditors were in bed with the accountants, and corporate heads weren’t held accountable for unethical practices. With Enron the whole Ponzi scheme came crashing down. The SOX act hoped to curb all this by increasing transparency, corporate responsibility, auditor independence, and remove conflicts of interest.

And indeed it did! According to a study in 2010, SOX enhanced transparency relative to comparable firms not subject to SOX. It also led to lower borrowing costs due to improved internal control. And those companies also had greater increases in share prices than non-SOX regulated companies. So declare victory and move on! Right? Right? Well, hold on a sec…

But what about costs? Nothing is for free! The SOX act dramatically increased compliance costs – some estimate around $1.4 trillion since SOX went into law.[1] Additionally, companies whose revenues were significantly smaller than large corporations had disproportionately larger compliance burdens. So much so, that in 2007, 70% of respondents said public companies with revenues under $251 million should be exempt from SOX.

Oh wait, there’s more! While SOX has helped companies from poorly regulated countries who list on the NYSE, the costs are incurred by countries from developed countries with tighter regulations. SOX is also attributed with helping displace business from NY to London where regulations are a bit lighter. This has put us at a competitive disadvantage on the world stage in an era where we are already not creating enough jobs. In a combined study from Stanford and Harvard Business Schools in 2008, the authors conclude that following the act’s passage smaller international companies were more likely to list in stock exchanges in the U.K. rather than U.S. stock exchanges.[2]

A recent Wall St. Journal editorial said [3]:

One reason the U.S. economy isn’t creating enough jobs is that it’s not creating enough employers… For the third year in a row the world’s leading exchange for new stock offerings was located not in New York, but in Hong Kong… Given that the U.S. is still home to the world’s largest economy, there’s no reason it shouldn’t have the most vibrant equity markets-unless regulation is holding back the creation of new public companies. On that score it’s getting harder for backers of the Sarbanes-Oxley accounting law to explain away each disappointing year since its 2002 enactment as some kind of temporary or unrelated setback.

And Ron Paul, on April 14, 2005 in a speech before the House said:

These regulations are damaging American capital markets by providing an incentive for small US firms and foreign firms to deregister from US stock exchanges. According to a study by a researcher at the Wharton Business School, the number of American companies deregistering from public stock exchanges nearly tripled during the year after Sarbanes-Oxley became law, while the New York Stock Exchange had only 10 new foreign listings in all of 2004. The reluctance of small businesses and foreign firms to register on American stock exchanges is easily understood when one considers the costs Sarbanes-Oxley imposes on businesses. According to a survey by Korn/Ferry International, Sarbanes-Oxley cost Fortune 500 companies an average of $5.1 million in compliance expenses in 2004, while a study by the law firm of Foley and Lardner found the Act increased costs associated with being a publicly held company by 130 percent.

Ron Paul was one of three members of the House who voted against SOX in 2002.

And whatever else can be said in favor of SOX, it still didn’t prevent a near total collapse of the financial sector in 2008! Greed and dishonesty finds a way despite whatever regulation is put in place.[4]

Look, we all want the folks running the show to be honest. And executives haven’t won any brownie points in the eyes of the public by buying up private jets and frivolously wasting money on extravagant luxuries. But in our system, the banks are in bed with the lawmakers (who also enjoy those same jets and luxuries incidentally). Financial regulation, as good as it sounds on paper, is often not enforced as well as it ought to be.[5] And too often unintended consequences are either not analyzed well enough or are legitimately unknowable (though I claim Ron Paul does a pretty good job of seeing many of them).[6]

I am absolutely in favor of good legislation that increases transparency, reduces dishonesty, helps us keep corruption out of our gov’t and corporate sector, and minimizes unintended consequences and inefficient allocation of resources. The problem is, most legislation and regulation doesn’t! And in the meantime we end up creating problems down the road requiring further regulation to fix!

Free market proponents don’t believe that the free market will solve all our problems. They are not under the illusion that there won’t be poor people, or that greed and corruption will cease to exist. But those things always exist, and in the meantime the primary victims of most regulation are the poor themselves (you don’t think those corporations use their profits to pay for increased compliance costs do you?), the folks we think we’re helping (hint: the poor are always the victims)!

[1] Economic Consequences of the Sarbanes-Oxley Act of 2002 (warning: PDF)

[2] Piotroski, Joseph D. and Srinivasan, Suraj, Regulation and Bonding: The Sarbanes-Oxley Act and the Flow of International Listings(January 2008).

[3] America as Number Two, Wall St. Journal, January 4, 2012

[4] In anticipation of the naysayers, I do recognize that the effects of SOX are hotly debated, and that I’m mostly representing one side of a very complex issue. But even admitting that to me suggests that this legislation was hastily crafted and voted into law without really examining the unintended consequences. And no matter how you slice it, we now reap the benefits/consequences which are clearly mixed at best!

[5] Mike Mayo.

[6] A few Ron Paul predictions (try to ignore the cheesiness of this video). Seriously, Ron Paul predicts so many things accurately I just can’t understand why people think he’s crazy. Rather, I think he’s almost the only sane one in Washington at all! Him and Kucinich.