A letter from a listener


Author: Timothy Sandefur

I got an email from someone who listened to my Armstrong & Getty appearance this morning, talking about regulation. Here’s the email (all the ellipses are his) and my reply:

Sorry, I cannot find a “contact” link on timthelawyer site. Not the ability to comment on your blogs there.

I heard you on A&G this morning discussing regulation.

Well, let’s see. The derivatives market lived essentially without regulation since, well, forever. That worked out real well, didn’t it…..

(Long Term Capital Management in the late 90’s and the mortgage implosion in the later 2000’s)

As for free market regulatory agencies, we had Moody, S&P and Fitch are private companies who all rated those derivatives as AAA. That sure worked out well, didn’t it…..

Zoning is a form of government regulation. You interested in repealing all zoning laws and letting the market decide whether of not I buy the house next door to yours, then open a fish processing business in my garage and a solid waste disposal operation in my backyard?

Just wondering.

BTW I thoroughly enjoy listening to you on A&G. I just don’t buy many of the Friedmanesque absolutes the free market people espouse.

I answered,

Dear ____,
You seem really hostile, so I’m not sure if you’re trying to just attack me, or if you actually are interested in learning about my views. I will extend you the courtesy of taking your questions seriously and giving you my answers, but if you’re not interested, of course, you can just ignore what I say.
First, I think it’s unfair to refer to “Friedmanesque absolutes,” when I think it’s obvious from what I say that I did not take an “absolute” position at all. I said repeatedly that there is a role for government regulation to protect consumers. I said, for instance, that government should enforce health regulations to protect people at restaurants. What I said, though, was that we shouldn’t think that government is going to solve these problems, because government is subject to a lot of limitations—it can’t gather necessary information, it’s subject to lobbying, it has perverse incentives which encourage it to be overly cautious or respond to political pressures rather than what consumers want. You don’t seem to have any response to these points, but simply demean and ridicule what you inaccurately call “Friedmanesque absolutes.”
Second, what you say about the derivatives market implies that you think the current economic downturn—the failure of Long Term Capital Management, and so forth—resulted from a lack of regulation. But the economic downturn was, at least in very large part, the result of the real estate bubble that was created by the federal government’s efforts to encourage home ownership: insisting that banks lend money to risky borrowers, manipulating the interest rates, and providing guarantees to Fannie Mae and Freddie Mac. In reality, the banking and lending industry and the stock market, are two of the most heavily regulated industries in the world. They certainly don’t suffer from a lack of government oversight. But a lot of time that oversight is perverted by political pressures (George W. Bush’s “ownership society,” for example) so that they don’t reflect the actual risks and rewards of the economy.
But putting that aside, it’s also true that businesses often make really dumb decisions, or defraud people. I mentioned Enron, for example, as an example of terrible private fraud. But, as I said, the government, which allegedly prevents such things, didn’t fire bureaucrats or send them to jail when Enron collapsed. Enron’s employees lost their jobs or went to jail. The government was not that accountable. To emphasize: I agree with you that people make bad or corrupt or stupid decisions all the time. So why should we trust people with the government’s power to rule over other people’s lives? The spectacular failure of Long Term Capital Management—a group of very smart folks with strong incentives to predict the future accurately—is actually proof that government bureaucracies can’t possibly predict the future, since they probably aren’t smarter, and they certainly lack the incentives to get it right that LTCM had.
The argument for the free market is not based on the idea that people will always make smart or responsible decisions. It’s the exact opposite: it’s that people so often make dumb, irresponsible decisions, that they shouldn’t be allowed to impose those decisions on the rest of us. Government is operated by the exact same people who make dumb, irresponsible decisions in the private market. As Thomas Jefferson said, “it is said that man cannot be trusted with the government of himself; can he then be trusted with the government of others?” This concern is heightened by the incentives I talked about—what economists call “rent seeking.”
Now, you mention Moody, S&P, and so forth rating derivatives as AAA when they shouldn’t. But you didn’t mention that when S&P lowered the credit rating for the government, the government responded by initiating a threatening investigation of S&P! No private company could do that. If Visa says I’m a bad credit risk, I can’t bully them. But the government—knowing it’s a bad credit risk—simply retaliates against the agency that says the truth about them? Again, private companies do many bad or irresponsible things. But I still have the freedom to shop somewhere else. I don’t have that freedom when it comes to the government.
As far as zoning is concerned, I do believe that the private market would do a better job of land use planning. (On this point, check out Professor Bernard Siegan’s classic book, Land Use Planning Without Zoning.) As I’m sure you know, private industry plans out land use all the time—master planned communities, for example. The question is, which is preferable: government planning, or free market planning?
Two points:
First, if you look at the zoning map of, say, Manhattan, it would be riddled with crazy exceptions and exemptions and waivers and variances and so forth. It is not an orderly planned community. In the free market, it would probably look about the same—all zig-zag and crazy land uses next to each other. But the difference is that under zoning laws, the decisions about land use are made by government bureaucrats who respond not to what consumers want, but to political pressures. They decide, based on who shows up at the city council meeting, or what makes the politician look good, and so forth. In the free market, those decisions are made by consumers and suppliers bargaining about what they want. Neither one is perfect—I do not believe in what you call “Friedmanesque absolutes”—but the free market version responds to what consumers actually want. The government version responds to what politicians want.
Second, as I said on the show today, government planning is subject to a lot of nasty pressures we don’t like to talk about. Zoning was originally invented at the beginning of the 20th century to keep racial minorities out of white neighborhoods. It’s a nasty, nasty history. And it worked well—and still works well. Of course, private market land use planning also did the same thing, with racially restrictive covenants, for example. But it’s important not to imagine that zoning laws are “rational” while private markets aren’t. Both are subject to mistakes and corruption and perversion. But in the free market system, I have a choice not to do business with mistaken or corrupt or perverse people—while in the government version, I don’t have that power. I have to obey laws created by mistaken or corrupt or perverse people, or they will throw me in jail.
Again, I’m happy to discuss these matters with you, if you’re interested. If you simply meant to attack and insult, then forgive me for wasting your time. But I believe that when we fairly consider the merits of my argument—that government is not better, and is probably worse, than free market institutions when it comes to protecting the consumer—that I am correct to strongly distrust (though not to totally abandon) government regulation.
Timothy Sandefur
Pacific Legal Foundation