Government Regulation

Political Philosophy
1

The level of regulation in Singapore’s financial market (and mostly everything else) is crazy.

The Central Bank of Singapore or MAS (Monetary Authority of Singapore) regulates the financial market in almost every place one can think of.

MAS, together with SGX (Singapore Exchange) which is the stock exchange, are in a sort of partnership to regulate the banking, insurance, securities and futures industries. And their reason for enforcing such regulation is to “safeguard investors’ interests, prevent industry malpractices (ensure markets are fair, efficient and transparent) and minimize systemic risks.”

I tried to reason with my lecturer that regulations aren’t necessary in a laissez-faire capitalistic society. He countered by saying how then do we prevent the likes of Bernard Madoff and irresponsible financial companies from taking advantage of the situation which will eventually result in the loss of thousands of jobs. His issue centrals around the loss of jobs. I explained that, in a free-market society, a company’s best rational self-interest is not to manipulate or abuse their consumers. I agreed when he said that there are bound to be a few irrational people who will take advantage of the system and they will cause many job losses when the companies collapse or create a giant Ponzi scheme like Madoff did.

If there is a complete separation of state and economics, what will prevent the “industry malpractices” which could cost jobs or prevent another Ponzi scheme from happening? Should the government ensure that individual rights are maintained in the financial market?

2

There is a connection between regulation and job losses: the people who clamor for regulations are the ones responsible for the job losses. But to respond, you first need to define, what is regulation, what is an “industry malpractice” because it’s not exactly clear from your post.

The only job of the capitalist government is to ensure individual rights are being maintained, in all markets, at all times. This means people like Bernard Madoff are criminals and would be treated as such. (Under a mixed economy, the government itself runs Ponzi schemes under the color of law on a scale that Madoff would never be able to get away with.) Regulations aren’t the same as anti-fraud laws. Regulations themselves violate individual rights by preventing peaceful market activity, while an objective system of laws would be aimed at preventing theft, fraud, and deception and outlawing them from the marketplace, including financial markets. Regulations “hamstring the innocent” and do nothing to stop actual thieves.

What is industry malpractice? Stealing? Well that’s illegal as is, so what basis is there to coerce me into harming myself?

So, the argument that de-regulation caused Madoff, or allowed Madoff to exploit “the system” is false. In fact, the SEC does about everything but concentrate on preventing force and fraud by trying to “make things fair” with “checks and balances” and doing what bureaucrats believe will benefit “the public good” and “improve” the financial system. “The system” itself is designed to boom and bust because it is a system. It needs to not be a system.

If you are worried about jobs, then you must cease all government economic and industrial engineering and interventions that prevent people from acting in their own self interest and creates malinvestment and distorts incentives. The role for the government is to catch the swindlers, stop all regulation and abolish the central bank (which is at the center of job losses, not one Bernard Madoff.)

Also focus on the ethical issue rather than the utilitarian issue. There is no right to initiate force, ergo there is no right to “regulate” as the modern term is understood.

3

I tried to reason with my lecturer that regulations aren’t necessary in a laissez-faire capitalistic society.

Laws are necessary though.

If there is a complete separation of state and economics, what will prevent the “industry malpractices” which could cost jobs or prevent another Ponzi scheme from happening?

Isn’t it interesting that people talk of Madoff when he is partially the product of a highly-regulated regime. This is not someone who was flying under the radar of the regulatory agencies. They actually received detailed (though circumstantial) information about why he was probably doing something fraudulent.

One big problem that comes from regulation is that individuals start to rely on the fact that regulators are covering the bases that they ought to be looking at. For instance, the FDIC killed the really good banks. There used to be banks that had nearly 100% reserves.

In stocks and mutual funds, the government does not offer such a guarantee – thank heaven! Yet, the government checks and approvals lull investors. Basically, when you have bureaucratic rules, everyone who sticks within those rules has his excuse. So, those around Madoff have their cover, allowing a small team to pull a huge fraud. Without government, people investing a few millions would have at least a simple checklist of things that they would want to confirm before parting with their money.

One such thing is: who is the custodian for the securities? Is it a reliable entity that is separate from the investment manager? This question reflects a standard and simple-to-implement audit control that has been around for centuries. Yet, the individual investors did not bother to ask. Why? I blame regulation for a part (but not all) of it. With regulation, investors are lulled into a sense that all the “obvious” loopholes have been taken care of. Also, because of regulation, people routinely get 100-page documents to read, with every possible warning in the world, that they no longer take any such warnings seriously.

Of course, one will always have Madoffs, because people fall for the temptation that these con-men throw out. I don’t believe most of Madoff’s investors are as innocent as one might think. They did not deserve to be fleeced, but many of them got into this thinking that Madoff might actually be skirting the law in some way in their favor. This too is a standard trick of con-men. I don’t think the mark really deserves to be conned, but they’re at least partly responsible for their own loss. BTW: The accusations against Madoff – only slightly toned down – were the subject of a short article in Barron’s. So, his investors did have some warning.

4

I understand that the government must have laws in place for force and fraud. But should such policies be proactive or reactive?

Should the government take an active role in preventing force and fraud? Or should the government take a reactive role in punishing those who exact force and are fraudulent?

Yes, I agree with Nerd that “with regulation, investors are lulled into a sense that all the “obvious” loopholes have been taken care of. Also, because of regulation, people routinely get 100-page documents to read, with every possible warning in the world, that they no longer take any such warnings seriously.”

Without such regulations, one should think investors would wise up and start planning their investments with more caution and calculation.

5

I understand that the government must have laws in place for force and fraud. But should such policies be proactive or reactive?

Should the government take an active role in preventing force and fraud? Or should the government take a reactive role in punishing those who exact force and are fraudulent?

I think I know what those terms are supposed to mean, so the answer is “Government should be reactive, in prohibiting certain actions which, themselves, constitute force or fraud. It should not be proactive is prohibiting actions which ‘might tend’ to lead to actual force or fraud”.

The only important difference between statutory law and regulation in this respect is that regulatory law cannot result in imprisonment, and many forms of force or fraud should result in imprisonment. It follows that most proper law cannot be regulatory law, therefore most regulatory law is improper law.

6

David makes a good point. Regulations often protect the criminal. Everyone suffers under an assumption of evil intent, everyone pays for the regulatory agencies, and many offenses result in politically motivated token fines when they should be tried as crimes. Not to mention that huge regulatory bureaucracies are so faceless that they’re breeding grounds for corrupt officials. Asking how a freer system would prevent a Bernie Madoff is a distraction tactic, since the current regulated system sure as hell didn’t. The quest for the perfect level of regulation where nothing else will ever go wrong is a fallacy. Biology has an appropriate term for such a state. Death.

I just did a quick search on Madoff. Lots of SEC ties there to go right along with those investigators that were positive something wasn’t right. One even married into the family after his tenure as the guy who was responsible for finding Bernie Madoff type crooks. I’m sure those large political contributions didn’t hurt Madoff’s scheme either.

7

I think I know what those terms are supposed to mean, so the answer is “Government should be reactive, in prohibiting certain actions which, themselves, constitute force or fraud. It should not be proactive is prohibiting actions which ‘might tend’ to lead to actual force or fraud”.

The only important difference between statutory law and regulation in this respect is that regulatory law cannot result in imprisonment, and many forms of force or fraud should result in imprisonment. It follows that most proper law cannot be regulatory law, therefore most regulatory law is improper law.

I get what you mean David.

But my people has a “Prevention is better than cure” mentality and thus approves of our Government actively participating in, as you said, prohibition of actions which might lead to force or fraud.

How about situations where there is already a fraud going on and it is due to active government inspection that the fraud is discovered and subsequently dealt with?

If there were no such active policies, the fraud could have ballooned into something huge and the aftermath would be disastrous. (That could be the justification for active Government policies: preventing disastrous aftermaths with ongoing frauds)

How is the Government’s reactive policies going to restore the balance? Let’s take the example of Madoff and assume that the SEC takes a reactive stance to force and fraud, what could happen is Madoff committing his treacherous Ponzi scheme undetected and it is only when his scheme ultimately self-destructs and reveals itself, the Government steps in to punish Madoff. There is going to be a massive trail of destruction (more than US$50b of capital gone, etc). Whereas if the SEC is vigilant and actively pursuing those who are secretly using force and fraud, the Madoff scheme could be unearth earlier, deterring the potential aftermath.

Can this be a justification for active Government regulation which is to pursue those secretly using force and fraud and not potential force and fraud?

I’m anticipating the question “How then would the Government know which organization is participating in force and fraud?” The Government would have to inspect everyone to uncover the fraudulent ones which is exactly the situation we are against.

8

Let’s take the example of Madoff …

Okay, let’s take him then. Are you somewhat familiar with what he did? If so, can you point to one single, simple control or check that his investors failed to ask for, which was key to his getting away with his fraud?

9

Okay, let’s take him then. Are you somewhat familiar with what he did? If so, can you point to one single, simple control or check that his investors failed to ask for, which was key to his getting away with his fraud?

Yes, I’m quite familiar with what Madoff did.

It was the complacency of SEC and the thousands of Madoff investors which allowed Madoff to operate a Ponzi scheme undetected for so long.

Red flags were raised to SEC about Madoff as early as 1999 by financial analyst, Harry Markopolos, who tried to deconstruct Madoff’s strategy and could not replicate Madoff’s consistently positive rate of return using his mathematical models. Markopolos eventually decided Madoff was either running a Ponzi scheme or he was engaging in illegal “front running,” improperly trading in investors’ private accounts ahead of orders the firm received from outside clients.

In the following years Markopolos appealed repeatedly to SEC to investigate but the investigations yielded no result. Madoff’s investors on the other hand never asked questions. The attitude among them was that it was almost blasphemy to question the actions of a legendary investor. Markopolos described Madoff as “one of the most powerful men on Wall Street,” and that there was “great danger” in raising questions about him: “My team and I surmised that if Mr. Madoff gained knowledge of our activities, he may feel threatened enough to seek to stifle us.”

I understand that SEC, a government agency, hasn’t been effective in its role. My question is would a more vigilant SEC with active regulation policies be more effective in preventing such crime from occurring again? If SEC takes a non-investigative and reactive stance in a laissez-faire society, what would prevent the next Ponzi scheme?

10

Your premise seems to be that a market free from coerced regulation would not self regulate. Continuing with the example of securities, organizations would form to inspect and validate offers and firms. A level playing field is in everyone’s interest. Consumers would point to a securities inspection firm with a reputation for success and meticulous investigation and say “I want the firm I deal with to have their stamp of approval.” Securities firms would pay to get inspected and claim the reputation of having voluntarily met the gold standard of veracity and ethics. The inspection firm would have every interest in being as through as humanly possible because one scandal and they’re done for.

Your premise seems to rely on the assumption that private sector inspectors and traders are highly susceptible to corruption, while government regulators are immune to it. Read up on the Madoff incident, which is a real life example of a fraud that DID “balloon into something huge with a disastrous aftermath.” He was investigated for years by the SEC and they never did anything, despite investigators telling their direct superiors that something was obviously wrong with the operation. The whistle was blown on Madoff by Harry Markopoulos, an independent financial fraud investigator. discovered Madoff, not the “vigilant” regulatory agency. The SEC shrugged at obvious evidence for years, and had to be told repeatedly by Markopoulos that Madoff’s reported figures were not possible in the universe we occupy. The reason is that SEC regulators don’t make their living off of the SEC’s reputation. Just some rough numbers from a google search. Averaging a few different sources a rough estimate of the money stolen by madoff is around 10-20 billion, after seizing his assets. Reuters reports the budget for the SEC in 2009 to be 914 million and 907 million in 2008. There were 6 botched investigations of Madoff by the SEC since 1992. So doing a little math with the near billion dollars a year the SEC gets and the 17 or so years they had to discover the fraud, not accounting for other factors like inflation and subtracting a few 100 million for the smaller budget the SEC had in preceding years we can make a very rough guesstimate that the SEC took funds comparable or GREATER to what Madoff stole from the American people and still missed the largest investment fraud in wall street history, despite numerous warnings from industry experts. Oh, and Madoff’s wife and kids got away with it still in the millionaires club, despite every human being on the planet knowing they were involved. Even using just the budget for 08-09 thats 1.8 billion confiscated from the innocent to invest in utter failure. Bang up job on that proactive regulation and law enforcement. One guess on what the SECOND largest investment fraud in wall street history is.

Support of proactive regulation based on the assumption of “secret force and fraud” is no different than supporting proactive curfews and random vehicle and home searches to stop potential “secret” crimes.

11

I understand that SEC, a government agency, hasn’t been effective in its role. My question is would a more vigilant SEC with active regulation policies be more effective in preventing such crime from occurring again? If SEC takes a non-investigative and reactive stance in a laissez-faire society, what would prevent the next Ponzi scheme?

But launching investigations based on cause, like the various red flags Madoff’s activities raised, is reactive. The only thing not reactive is stifling legitimate economic activity, or requiring detailed accounts of everyone’s business, even if there is no reason to suspect a crime. Which is what the SEC is busy doing, while criminals simply lie, and continue committing crimes. (and of course almost everyone in the market is wasting resources seeking out loopholes in the system, to try to either get legitimate work done that’s not politically acceptable, or cheat).

Not only are these practices abusive, they don’t even work at preventing fraud.(most of the time they aren’t even meant to prevent fraud, but to provide selective “social justice” and make political statements) An SEC that investigates based on probable cause would be far more effective at the one legitimate job it has.

12

Ah…I see.

"Securities firms would pay to get inspected and claim the reputation of having voluntarily met the gold standard of veracity and ethics. The inspection firm would have every interest in being as thorough as humanly possible because one scandal and they’re done for. " - I hadn’t thought of this, about securities firms paying to get themselves validated.

Okay, I understand. Thanks for clearing it up, Jake and Castle.

13

Individual,

I realize you’re convinced that voluntary audits would work.

Still, I think it is relevant to point out that the key to Madoff’s scheme was: fictitious transactions. This is the oldest and most basic con that auditors face. For instance a company may fake sales, costs etc. by entering false numbers in their books. A bank could take your money and say they still have it (showing the numbers on your account) while the managers have actually spent it. In trading, a brokerage could take your money and tell you they’ve bought the stocks you tell them to buy, but they might not do so. They might show your trades “on paper”, and keep just enough money to pay out those customers who want cash.

The free-market has evolved a few ways to deal with this. Most basic are auditors. Madoff had these, since they’re mandated by law. However, his auditors seem to have been in his pay. The second technique – possible in the financial markets, but not in some other arenas – is the use of custodial services. For instance, a broker who handles your account might use some third-party service which actually holds the shares and the money at any time. The multi-person/multi-entity structure makes fraud more difficult. (Old banks used to keep separate cashiers to pay money out and to receive money, to reduce some opportunities of cashier-fraud.) A third method of protection is insurance, even if it does not go by that name. Even before the FDIC, some banks belonged to clearing-house associations, that would back their members up at times of crisis. In their turn, the clearing houses would impose certain rules and some disclosures upon their members.

Government regulators have a strong effect on making people less aware of the dangers of fraud. For instance, it is shocking that Madoff did not have to have his trades checked as being real, not use a custodial service. A private investor might well have thought that the government had his back covered. In a free-market an investor would be stupid to make such an assumption. Government plays a key role in throwing individual investors off their guard. Here is an example: more than half the adult population owns stocks via some account: retirement account or some other account. Suppose the entity holding this account collapses as a fraud or for some other reason. Are these accounts still safe in some way? I can bet that a majority of people who have such accounts have no idea in what way they are protected. They simply assume that they are: that the government must be looking out for them.

14

Individual,

I realize you’re convinced that voluntary audits would work.

Still, I think it is relevant to point out that the key to Madoff’s scheme was: fictitious transactions. This is the oldest and most basic con that auditors face. For instance a company may fake sales, costs etc. by entering false numbers in their books. A bank could take your money and say they still have it (showing the numbers on your account) while the managers have actually spent it. In trading, a brokerage could take your money and tell you they’ve bought the stocks you tell them to buy, but they might not do so. They might show your trades “on paper”, and keep just enough money to pay out those customers who want cash.

The free-market has evolved a few ways to deal with this. Most basic are auditors. Madoff had these, since they’re mandated by law. However, his auditors seem to have been in his pay. The second technique – possible in the financial markets, but not in some other arenas – is the use of custodial services. For instance, a broker who handles your account might use some third-party service which actually holds the shares and the money at any time. The multi-person/multi-entity structure makes fraud more difficult. (Old banks used to keep separate cashiers to pay money out and to receive money, to reduce some opportunities of cashier-fraud.) A third method of protection is insurance, even if it does not go by that name. Even before the FDIC, some banks belonged to clearing-house associations, that would back their members up at times of crisis. In their turn, the clearing houses would impose certain rules and some disclosures upon their members.

Government regulators have a strong effect on making people less aware of the dangers of fraud. For instance, it is shocking that Madoff did not have to have his trades checked as being real, not use a custodial service. A private investor might well have thought that the government had his back covered. In a free-market an investor would be stupid to make such an assumption. Government plays a key role in throwing individual investors off their guard. Here is an example: more than half the adult population owns stocks via some account: retirement account or some other account. Suppose the entity holding this account collapses as a fraud or for some other reason. Are these accounts still safe in some way? I can bet that a majority of people who have such accounts have no idea in what way they are protected. They simply assume that they are: that the government must be looking out for them.

The people in my country expect the Government to look out for them. We (I’m not one of them) actually want the Government to look out for us. That is the relationship between Singaporeans and their Government. Our Government has a sort of a paternal relationship with the people. We want the Government to do everything for us. We allow our Government to enter into the housing market to provide “cheap and affordable housing” for everyone who needs it. I cannot imagine how much our Government has profited.

Our Government plan our retirement by creating a mandatory social security plan which you can only withdraw from at 55 (retirement age) and there are so many ramifications to the plan. Basically the Government is planning everything for you till the day you die. And Singaporeans are proud to have such a “caring” and “people-centered” Government. I am revolted by the majority of spineless Singaporeans.

Singaporeans males are required to go through a compulsory 2-year National Service. We pay a 7% Goods and Services Tax for everything we buy. That means even a 7-year-old is being taxed when he buys his candy bar. We have a Water Conservation Tax. I could ramble on but I think I made my point. From the beginning since Independence Day, my people has been heavily dependent on our Government. We have allowed our Government to solve whatever crisis that comes our way, instead of being independent and tackle the problems ourselves.

How do we change? How do we shift the mindset of a people who has been perennially dependent on the Government?