Let me begin with a story. It's a true story, if maybe a little boring, but I want to use it as an analogy.
It was several years ago. I was helping my good friend Wally do something about the springtime runoff that turned his backyard into mud every year. His house was built on the side of a hill on a 2-acre lot that sloped down from the road. Every spring the melting snow would create a seasonal brook that ran from the other side of Wally's street through a culvert emptying into his side yard on the uphill side of the house. He had dug himself a channel to get the water past his lawn, but after that, with no other place to go, it would saturate the hillside turning it into a muddy mess. It got too sloppy for him to get his pickup down in back where at that time he was cutting firewood.
Our plan was to continue the channel downward across the hill, but once we got to working on it we almost automatically began looking to get the water to cut the channel by itself. We found likely spot where the flow of surface water was visible, and with the points of our shovels we scratched a groove in the dirt, through the trees, down and across the yard to the vacant lot next door. Water from each side seeped into the groove making a tiny rivulet down that ran down the hill.
We left it alone for a while, and when we went out later to check on it later, our little stream had grown a little wider and seemed pretty well established, but the hillside wasn't drying out to any noticeable degree. That would take days, but we were optimistic that our idea was going to work.
And it was some days later that Wally called, astonished at what became of our little stream. I went over to see it, and I was astonished myself. He had a little brook, about a foot and a half wide, but the little brook had carved out a stream bed that was three to four feet wide and a foot to two feet deep. Small boulders were unearthed. It was a thing of beauty. I thought so anyway. It was big enough that Wally had to build a makeshift bridge to get his pickup to the lower end of his lot, but the hillside dried out very nicely.
So here's the analogy. Just as our groove channeled the water to where water ultimately wants to go -- downhill -- America's legal framework, based on individual liberty and responsibility, provides the guidelines that are intended to keep us from ruining the proverbial hillside as we go about the business of living our lives.
There are two aspects to this. First is that the water created its own stream bed, just as we in America create our own law. At least in theory we create our own law. Rules and regulations might start out being relatively unobtrusive, and then get more elaborate as time passes and as needs (legitimate or otherwise) arise. Sometimes, though, laws and regulations seem as though they've been imposed by Washington against our will. Which brings me to the second point.
Passing laws that go directly counter to people's desires generally doesn't work any better than trying to channel water to run uphill. A great example of the negative unintended consequences of a law passed with good intentions is prohibition.
We can thank prohibition in large part for the rise in organized crime in America, because it was left to the criminals to fill our demand for liquor. While average Americans thumbed their noses at the law by frequenting speakeasies or making their own bathtub gin, criminals organized vast liquor supply chains, greased the way with bribes, and literally went to war with each other over control of lucrative territories.
This was not the way lawmakers thought the "stream bed" would go when they forbade people the consumption of alcohol. Progressives obviously didn't foresee that all that water, in the form of people's demand for liquor, wasn't about to dry up just because they were able to pressure lawmakers into legislating that it ought to.
Forunately, prohibition was an exception. For the most part we generally haven't allowed our government to put significant obstacles between ourselves and the things we want. The effect of this has been astounding. Sometimes it's hard to notice, or easy to credit other circumstances. We tend to take things for granted.
But in the historical blink of an eye, the land where we live, America, was transformed from a wilderness to a nation of astonishing wealth and power. The primary reason for this was America's legal framework which allowed people to pursue what they believe to be in their best interests. Contrast this with Egypt where legal barriers prohibit the vast majority of their citizens from the most basic economic pursuits.
Let me concede right up front that America's past includes injustice. Yes, land was taken from native Americans. It's true that the law did not guarantee every citizen the same economic opportunity. But neither conquest nor discrimination is an American invention, and they don't account for America's wealth and power. Even though different people at different times were barred, and none more so than African-Americans, more people than ever before in history were afforded the freedom to pursue opportunity in whatever way they believed would make their lives better. That is what has made the difference. Americans are the source of American power.
It may be interesting to consider that as hard as economic times have been recently, America is still the world's leading manufacturer.
But let's turn to the flipside of this "freedom to pursue" coin. The framework that permits us the liberty to go after our dreams also provides the sets of rules to follow as we chase them.
Libertarians generally make a big deal out of the power of market forces to regulate its participants. It's justifiable in many circumstances. We know from experience that competition tends to keep prices in line. We know that competition tends to improve the reliability of the things we buy. A highly competitive market tends to protect the consumer, but there are situations where a competitive market is not sufficient protection.
One of the many opportunities afforded me over the course of a career in information services was in the role of lead programmer on the development of a system designed to help brokerage firms comply with the SEC 15C3-3 Customer Protection Rule. The system dealt specifically with margin account segregation. And what, you may ask, does that mean?
One of the outcomes from the stock market crash of 1929 was the formulation of the Securities and Exchange Act of 1934, which among other things, gave the Federal Reserve Board authority to limit the amount a broker-dealer is allowed to lend to an investor for the purpose of buying stocks. Borrowing from the broker-dealer to buy stocks is called buying on margin. Federal Reserve Board Regulation T is the rule that limits the amount a broker-dealer can lend to an investor to 50% of the price of the investment. Prior to passage of the Securities and Exchange Act of 1934 an investor could borrow 100%. That created a stock market bubble in much the same way that easy credit created our recently deflated real estate bubble.
When an investor buys on margin, the securities purchased are collateral for the loan. Among other things, the Customer Protection Rule puts limits on how that collateral may be used by the broker-dealer, and it provides specific formulas for calculating just how many shares are collateral and how many are the customers' fully paid securities. These calculations, by the way, must be done on a daily basis since the value of the collateral, and therefore the number of collateral shares held, constantly changes with the rise and fall of share prices.
The Customer Protection Rule also requires that fully paid securities in customer accounts be in the possession or the control of the broker-dealer, whether they are in the firm's depository account, in the vault, or in another designated location. One thing this does is to insure that customers don't lose the securities they own in the event that a broker-dealer goes belly up.
SEC auditors descend upon securities firms annually to comb through their books. Among the things they look for is evidence of failure to maintain proper segregation of customer fully paid securities. They also look to confirm that every effort has been made to have customer fully paid securities in the firm's possession or control. Violations can mean heavy fines for firms and their officers, and can even result in a firm being shut down.
Here is a situation where competition by itself is not enough to protect the customers. Competition is necessary, but we also need those SEC regulations that compel companies to demonstrate that they exercise proper safeguards on the inventory of securities held on behalf of customers. Without SEC oversight customers have no way of knowing if a firm has the proper internal controls, or if it does have them, is it following them. The SEC's demand for transparency provides that additional and necessary incentives for broker-dealers protect their customers' investments.
The point of all this is to illustrate that we seek a balance. Ideally our laws and regulations will permit us to do pretty much what we'd like to do, while preventing us from stepping on the rights of others or causing them harm. This is not to downplay the importance of competition.
The beauty of competition is in the swiftness of its effect. It can be instantaneous. When consumers decide, in a competitive free market environment, that a product, or service, or a particular supplier no longer meets their needs, the negative impact on the producers and suppliers is an immediate and painful loss of revenue. There is no waiting around for consumer protection regulations or legislation to be formulated and passed. There are no loopholes, and the verdict is final. Companies either fix their problems or suffer severe consequences, even to the point of being forced out of business.
Government regulation that encourages competition is a necessary piece of our free market system. Unfortunately, there is a tendency for politicians to use regulatory power to protect favored interests, be they companies, labor unions, or other organizations. The capital-L libertarian argument is that regulation will always be corrupted in a way that favors the politically connected. There is much truth to that, and for that reason we need fierce competition in the market place and in the political arena to counter the tendency for favoritism and corruption.
As a side note, the current notion that Wall Street is loosely regulated is fairly wide of the mark.
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