History is pervaded by a hostility to financial markets, the common notion being that they create little tangible value, just artificial profits for the leech-like financers, speculators, and usurers.
This skepticism is quite old. Hammurabi’s code capped interest rates and regulated the terms of debt contracts to three years. In the Politics, Aristotle dismissed interest as mere “money born of money.” “Usury,” he wrote, “is most reasonably hated, because one’s possessions derive from money itself and not from that for which it was supplied.” In the 13th century A.D., Pope Innocent IV warned that “If usury were permitted, all rich persons would rather put their money in a usurious loan than invest in agriculture” and “Famine would result.” Such a misunderstanding of (and distaste for) financial markets has persisted, peddled by more modern thinkers, such as Karl Marx and John Maynard Keynes. The arguments hurled against financial markets have changed little over the years—or over the millennia, more like.
That well-functioning financial markets do, in fact, enrich the countries that cultivate them is the contrarian thesis of Financing Opportunity, a new book from the Cato Institute’s Norbert J. Michel and Jennifer J. Schulp. “The most important function financial markets serve is to help people allocate capital in the most productive way possible,” they argue. “To do this, many financial firms serve as financial intermediaries between people who want to provide funds to others and those who need additional funds.”
Simply put, financial markets allow those who have money but have little need for it to transfer it to those who lack it and need it. They make idle money industrious. Or, to repurpose the words of two-time National League batting champion Wee Willie Keeler—himself a prolific investor—financial markets send funds where they ain’t. The business clearly profits bankers, stock traders and hedge-fund managers. However, it also profits the ordinary person, who—rich in inspiration yet poor in capital—often cannot pursue his best ideas without outside funding. Banks “more frequently enable honest and industrious men, of small, or, perhaps, of no capital, to undertake and prosecute business,” as Alexander Hamilton put it. More recently, Phil Graham and Mike Solon noted that “Some 72% of the value of publicly traded companies in America is owned by pensions, 401(k)s, individual retirement accounts, charitable organizations, and insurance companies funding life insurance policies and annuities.” The Rolexes procured by financial markets for the hyper-wealthy are large enough and shiny enough to distract the average market skeptic from the security and prosperity—even into retirement—they have facilitated for the everyday American.
Every good story has an antagonist, and Financing Opportunity’s is the sprawling, incoherent, anti-competitive, innovation-killing, unstable regulatory regime that governs U.S. financial markets. Bureaucrats enjoy startling discretionary latitude and intimate powers to direct the everyday operations of (putatively) private businesses. Congress and the myriad alphabet-soup agencies that oversee various corners of financial markets have cooked up a witch’s brew of central planning, moral hazards, and arbitrary rule. Often, the character of the regulatory regime is less “Mother, may I?” than “Child, you shall!” What’s more, regulation by raised eyebrow — via such hazy legal constructions as “reputational risk”—has done great violence to Americans’ property rights and civil liberties.
As President-elect Donald Trump draws up plans for his second administration, his team has been gathering the political ordinance needed to blow the Washington, D.C. status quo to smithereens. But the bull-in-the-china-shop candidate has largely kept out of the financial-regulation aisle. The Department of Education? Afuera! The Consumer Financial Protection Bureau (CFPB), the Federal Deposit Insurance Corporation, the other agencies that are drowning financial markets in alphabet soup? Save for a few whispers, all that has been heard from the Mar-a-Lago is crickets. The high and mighty of Trump-world have not deemed financial deregulation a priority.
Even still, Trump’s appointees will do much good. For example, the Securities and Exchange Commission (SEC) will likely end its broadside against cryptocurrency and quit its extra-statutory adventurism as a climate regulator. Loosening the reins is no substitute for letting the stallion run free. So long as the structure of the regulatory state remains upright—with agencies, regulatory authority, and broad, discretionary enforcement powers—it will remain a source of central planning, over-regulation, and the concomitant instability and inefficiency. Only taking the Argentinian chainsaw to the very roots of control can ensure freedom prevails in financial markets.
The Federal Reserve, the SEC, and the CFPB, among others, deserve no deference. Intellectually, they sprung from the Progressive fetish for “disinterested” expert rule—as if any kind of governance exists that is not inherently subjective and political. Many Americans take for granted the forms and distinctions of modern financial regulation due to their decades-long continuance; but they should not be
Experience shows that hyper-regulation has not brought stability to American financial markets. To the contrary, it has brought dysfunction to working markets—dysfunction for which markets often take the blame. For example, as David Bahnsen argued recently, the Federal Reserve has suppressed interest rates, distorting markets and adding to the much-criticized phenomenon known as “financialization” (often blamed on “market failures” and the like). “That artificially low cost of capital extended the lifeline of many over-levered economic actors, and in the early years of post-crisis economic life likely facilitated some productive reflation,” Bahnsen writes. “Yet over time, the perpetual zero-bound rate target encouraged economic actors to bypass the production of new goods and services for financial engineering.” As so many other interventions have done, the Fed’s best laid plans for low interest rates muted the signals the market was veritably screaming, depriving businesses of badly needed information and dampening growth and prosperity.
One cannot read Michel and Schulp without sensing that the statutes and regulations governing financial markets are less the inarguable product of disinterested scientific empiricism than the guesses of generations of regulators, often subject to politicking, compromise, and rent-seeking. Politicians and bureaucrats cannot, in practice, judge risk better than private citizens. Particularly in opaque, abstract markets such as financial services, regulatory analysis amounts to guesswork. And when regulators dream up and impose broad, sweeping plans, they all too often concoct complex mazes of perverse incentives, which cause market actors primarily to pursue compliance, not good business (never mind the rent-seeking that inevitably crafts such laws). The notion that administrative agencies, if insulated from political forces, can be staffed with scientist- or economist-bureaucrats to hand down wise and just rule from on high was always a scientistic fiction, set against the fundamentals of the American founding. This obtains in all markets, not just in financial services.
Market skeptics have long condemned “speculative” investment. Michel and Schulp warn against foolish efforts to cull the “good” investments from the “bad” ones. Any regulatory attempt to do so will prove subjective and arbitrary. Individuals know their own business, and they ought to be allowed to employ their money towards what is, in their own view, its best use. Overconfident central planners disrupt the price discovery, risk mitigation, information provision, and other functions free markets provide. And in financial markets, as in all others, knowledge problems loom.
The Republican party is abuzz with talk of reviving the spirit of ’76—of replacing political power in the branch of government in which it belongs, Congress. As it takes power in both chambers of Congress and the White House, the GOP should turn this impulse towards the financial-services industry, whose regulators are nearly unparallelled for their heavy-handed bureaucratic rule. Doing so will redound to Trump’s political benefit. Freeing financial institutions—or subjecting them to market forces, if you prefer—will allow Americans, rich and poor alike, to capitalize better on their advantages and talents. A freer flow of money will yield greater prosperity.
Moreover, free financial markets are quintessentially American. They have flourished in the U.S. since its inception (though not without their critics). As with most endeavors, early Americans fell to creating a financial-services industry with great vigor. The New York Stock Exchange emerged in nascent form in 1792. By 1794, state-chartered American banks outnumbered English incorporated banks by more than threefold. By 1825, the American equity market’s total value had almost reached that of its English counterpart, and the American banking system boasted nearly 2.5 times the capital of those of England and Wales combined.
Financial institutions provide many services and occupy a hyper-complex, baffling ecosystem. It is a fact of man’s nature that he suspects what he does not understand. The labyrinthine complexities and staggering profitability of financial markets often illicit two emotions: bewilderment and envy. Neither begets good policy.
Financing Opportunity does much to explain the antipathy to finance so common throughout history. In demystifying financial markets, Michel and Schulp provide not just a primer to Americans unfamiliar with the intricacies of financial markets and regulation—i.e., most Americans—but a public service. The Trump team should read it.
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