Creating Infrastructure for Private Regulation

Creating Infrastructure for Private Regulation
by Alex Merced

 Everyone on both sides of the aisle have empathy for consumers who are defrauded, swindled, and are tricked into entering trade under false premises. The debate isn't should there be mechanisms to protect and put oversight on the consumer market that'll help prevent these kind of problems, but what should the mechanism be?

 Those typically on the Right believe in the markets ability to take care of itself, and that firms that participate in fraud will eventually fail since they'll cannibalize their consumer base, and only legitimate reputable firms will exist when all is said and done that regulation of any form shouldn't exist cause it inhibits the level of competition that'll keep prices reasonable for consumers and allow pressure to keep firms honest.

 Those typically on the Left believe that even if this is true, the market will leave massive collateral damage in the wake of weeding out these fraudulent firms. They advocate regulating industries into "best practices" via government run regulatory monopolies also known as regulatory agencies. While this may have some effect on prices and the amount of competition, they feel the amount of confidence that consumers will have will outweigh the costs since consumers will feel safer to spend more.


The Problem with both of these positions

- The amount of collateral damage from having no mechanism for oversight can and will deter market confidence for sometimes long periods of time, which can create a society that is skeptical beyond necessity. This can actually inhibit the amount of investment and consumption in the economy.

- Centralized oversight from government monopolies are heavily subject political conflicts of interest and regulatory capture, and since there is no alternative it becomes the equivalent of no oversight but with the added danger of a public that thinks they are being protected and behaving as they are. (Imagine jumping out of plane thinking you are wearing  a parachute, but really they gave you a backpack of bricks, you feel perfectly safe till you hit the ground)

- Overconfidence is just as bad as no confidence, not only is fraudulent firms a problem but also is overconfidence by consumers to trade without doing their due diligence.

- Government enforced monopolies which use police/legal force to force best practices only make it more expensive and difficult for new start ups to compete against larger more established firms who might become more fraudulent feeling safe from competition and also grow too big because of this protection allowing them to capture regulators.

So Then what does Ideal Oversight look like?

Ideal oversight would come from a market of regulation, where competing firms compete to earn fees from consumers for regulatory services such as product reviews/rankings, product disclosures, and consumer education. This offers several benefits:

- Avoid regulatory capture since consumers can switch regulators when one regulator becomes too corrupt

- Since participation by the consumer and the firm is voluntary, consumers don't feel unduly protected unless paying for regulatory service and by trading with firms approved by that regulator.

- This allows for oversight with minimal collateral damage, doesn't move the barrier to entry since compliance with any of these regulatory companies is voluntary (if you don't, you don't have access to their members as customers)

As with anything the answer is not to have something or to have central provision of it, but to have market provision of the service or good. Although there is one way the government can help in fostering such a market in private regulation, by helping establish a model for consumers and regulators to find each other and disclosure of information. While I am against all government intervention, this is more a method to transition from the current monopoly to a regulatory market. To understand my proposal we must understand the logic of the securities act of the 1933.

The Securities Act of 1933


 In the 20's most of the communication technology we take for granted today didn't exist or was in it's earliest stages. A investor looking for an investment had no internet in which to pull a particular companies financials or information to base a decisions off of, only what a broker chose to provide them who had a conflicting interest in getting them to like any particular investment cause of commissions.

 So the logic of the act of 33 wasn't to prevent companies of varying quality to make their securities available to the public, but instead to require that the sale of the securities be made through a disclosure of information we now know as a prospectus. Also, these prospectuses must be registered with the Securities Exchange Commission to make sure all proper disclosures are made.

 The basic idea of disclosure is one of the most interesting parts of this act, it wasn't about making the decision for a customer in what's good for them in the way the FDA does with drugs or more modern financial regulation may do but instead empowering the consumer to be able to carry out their responsibility of making a decision.

 As technology involved, access to information has evolved with the internet and now the SEC has their EDGAR database in which anyone can look up all this disclosure information for any company. Although again, this was not perfect for many reasons...

- The SEC is a public monopoly that use legal/police force which tends to make consumers feel unduly safe so while there is more disclosure retail investors have less incentive to read it feeling the SEC has broad enough jurisdiction

- Consumers will deal with any firm since they assume that all firms are registered with the SEC, instead of looking for an approval sticker or id of some kind (although Broker Check was made to address this, they'd be more willing to use such a service if they were educated to use it)

If the SEC was established not as a monopoly but as a model for what other firms can do as a regulatory business, other firms would approve on many of the shortcomings of the SEC in order to take their market share. A Market would develop and the competition would eventually allow a phasing out of the SEC and the expense for the government... of course government doesn't like competition with their agencies or phasing out power which is just the problem with governments themselves (thus why I'm an anarcho-creatarian).

How do we apply this to today?

The Government could establish a model, an online platform where regulatory businesses can put up all their information and allow consumers to subscribe to their services. The government could of course put stipulations similar to registering a prospectus to putting your company on this platform and take assessments on subscription fees to help fund the platform so it doesn't use taxpayer money.

This platform can categorize all these private regulators by industry, geography, and by services offered. Education materials can be made available on this platform on how to use the services from these regulators, and profits from assessments can be used on ad campaigns (similar to Got Milk commercials).

This should be done in a non-coercive way, regulatory companies are not obliged to post on this service although they stand to benefit from air of legitimacy they'll get and marketing from ad campaigns. Also other companies should be free to create their own competing platforms so this way eventually the government can either close the platform as it loses market share to more innovative platforms or sell it to buyer of their choosing.

This would handle many issues of oversight, regulatory capture, consumer confidence, anti-competitive, and other issues prevalent with the mainstream right and left views of regulation.

Free Market Regulation Explained

Free Market Regulation Explained
by Alex Merced

Everyone always assumes that  as free marketers that we advocate there be no regulations at all, but the truth is we think there should be no government monopolies of regulation or violence used in enforcing it. Then the response always is, if the government can do it then people won't. Although there are plenty of ways regulation can be done for profit in a way were the regulators have consumer interest more in mind than they do now. You've probably already read plenty of articles of the effects of government regulation as far as eating up resources and raising the barrier to entry reducing competition for the very firms your trying to control so let's take a different approach.

The intended or perceived intention of regulation is consumer protection, and we've seen that this is not always the result for one key reason, any entity is beholden to the people who fund it's operations in this case government. People think of the government as a intermediary of the people but while they are publically elected they are politically motivated. Since they truly hold the DIRECT power to fund these regulators, the regulators are beholden to them and their political goals (Bush, Dodd, Cuomo, Frank w/ lending regs) instead of pure consumer protection. So as politics distorts the mission or purpose of a regulator, consumer protection falls by the way side.

This is also an issue with private sector SRO's since they are usally funded directly by the firms in the industry they are regulating so they are beholden to those firms. If these's SRO's such as FINRA etc. enforced the rules closely on their biggest constitutents (Goldman Sachs) it'd greatly effect the inflow of cash for their operations so once again consumer protection falls by the way side.

The bottom line, a regulator will always be beholden to those that pay their bills, so if you want them to protect the consumer they must be paid by the consumer directly. Even then, a regulator isn't infallible so allowing a market of regulators that consumers can volunteer to pay into and firms can volunteer to deal with to get to those consumers will allow the correct incentives and pressures for the regulatory firm to advocate on their customers behalf (such as for-profit lawyers, you hire them to protect you. Also this structure is similar to AARP or other groups you pay memberships for).

This market of regulators shouldn't have any type special power handed over the government, since we've seen that ever mixing private/public institutions ends in disatrous results (Fannie, Freddie, FINRA, Sallie Mae, etc.). Industry firms will try to strike deals with as many of these regulatory firms as possible to have access to the consumers who hired them as their intermediary, and the industry firms that strike these deal will voluntarily be monitored by these regulatory firms who will then promote and recommend these firms monitored by them to consumers who pay for the regulatory firms services. Everyone who participates in this protection is doing so voluntarily but cause of the pressure created directly by consumers.

Another way to regulate in the free market is through review publications as we see in entertainment magazines that review the music and movies we enjoy. Musicians and Entertainers operate with the pressure of getting good reviews or have their success effected by it, although if one reviewer were to write good reviews for bad movies his audience would shrink and more over to another reviewer putting pressure to remain honest. Also, if one reviewer opinion is drastically different than other, this would also call into question the quality of his review. Although these review magazines are paid for directly by consumers, so they are beholden consumers.

Although in the case of securities rating agencys, giving them psuedo government power by keying legal regulation into their ratings created a perverse incentive to cater to their clients (the buy side) into rating things highly so they can legally leverage them. If there wasn't these coerced limits by government regulation, these rating agencies wouldn't of had the same pressures to rate the Mortgage Backed Securities AAA.

Even without the free market of regultors and review publications there is the ultimate free market regulator, consequence. If consumers and providers feel there are consequences to their risks, and there is nothing mitigating this consequence (FDIC, SIPC, Federal Reserve) then the risk will typically prevent them from taking "Irrational" risks, and those that do will suffer the consequence and serve as  a warning to others.

At the end of the day, protection of the individual is the responsibility of the individual. If the individual does not take the time and isn't willing to directly be involved in their own protection the protection they do get will never truly be on their side and the world around them will stagnate from the results. To fix the world you need more aware and active individuals, willing to pay for their own protection, willing to get involved in protecting themselves and truly understanding every individual decision they make.

The Effects of Public Policy on Private Activity

The Effects of Public Policy on Private Activity
by Alex Merced

One of the problems of people who advocate for a growing role of government is that they operate in a mindset of unlimited resources, or that a growth in government has little to no effect on their current resources. The reality is that the economy has a static and generally decreasing amount of resources, so when the economy is being productive innovations will help us use less of these resources to accomplish our day to day tasks. This is the benefit of a free market or private activity, the innovations that allow the shrinking pie to be spread even further.

For these innovations one needs investment, capital, and ideas. Capital gravitates towards ideas, cause good ideas will serve as a magnet for even more capital, but again there is a limited amount of capital to gravitate towards these ideas. So essentially, to survive in a world of growing scarcity you need innovation which needs investment which is maximized by freeing up capital for investment.

So where does the government fit in on all of this?

Since there is limited resources not all of society will get fair slice of the pie, or even slice at all. Overtime though this percentage should shrink as innovations will free up these resources travel to more and more people in a variety of ways. Although people generally grow impatient for this to happen and will call for programs to watch for the welfare for those who are unable to get a piece of the pie. Although these programs themselves must take resources from this pie/economy to watch for the currently small amount of people outside of it.

The government has two ways to move resources from one place to another:

1. Government can tax the people and redistribute those resources to the outsiders, although the people are taxed this means the people have less resources to invest or consume, and since the potential consumption of a potential innovation is diminished the amount people are willing to invest in it is reduced.

2. Government can borrow the money but there is limited amount of loanable funds, so if the government borrows these funds then they can't be borrowed to invest in innovations also hampering the innovation process.  Even worse, to pay this debt with interest the government must tax later resulting in the effect previously mentioned. So borrowing has a worse effect than taxation since it reduces current lending and future consumption.


The result:

In the end, after taking these resources out of the economy, the economy has less resources to support the population that it was able to support before (it's productive capacity has been reduced) and now even more people fall outside of the economy creating a demand for growth in the social programs previously established. The growth in demand will increase the size of these programs and increase the size of resources that must be taken out of the economy creating a cycle that drives more and more resources into these "public" programs and away from private production.

So while the public sector has gotten larger and larger, the world has survived in spite of this cause the innovation that has occured has minimized the impact of this resource drain. Innovation is the key to battling scarcity and in this case you want resources free to gravitate towards ideas meaning the public sector must be dismantled.

How to repair a bankrupt country

How to repair a bankrupt country
By Alex Merced

Well continuing with the balance sheet analogy of my previous post, how does a bankrupt company survive bankruptcy and what is bankruptcy. In order for a company to survive it must have enough assets to pay of it's creditors which are part of it's liabilities, if it can't do this (which means there's no more equity) then the company must go into bankruptcy. In bankruptcy the company will attempt to do a few things:

1. Try to restructure the terms of it's liabilities
2. Try to exchange liabilities in exchange for Equity
3. If possible to see if people will forgive debt (wouldn't bet on this)

So basically for a country as the economy shrinks to the point where there is little to no private sector and just a public sector this is an economy in bankruptcy. So how would we use the bankruptcy approaches above to fix this problem?

1. Restructure the costs of the Public Sector by lower wages, laying off excess public workers, and lowering the amount budgeted to parts of the private sector.
2. Turn some public programs into privately run services or programs which allow entrepreneurs to find ways to provide the same service in a profitable and cost efficient way, without the moral hazard that running at a perpetual loss a public program can cause.
3. Or completely end programs and services who's costs can't be reduced and can't be privatized.

All three of these actions will result in more resources for a larger private sector means for a resilient and vibrant economy as I described in the previous post. In a country like the US that is quickly growing into this bankruptcy scenario it's time to start advocating drastic measures like this before it's too late.

The Economy is Like a Balance Sheet

The Economy is Like a Balance Sheet
by Alex Merced

Everyone Company and Person has a balance sheet. The balance sheet is made up of two sides:

One side has all the assets which is all the stuff the entity has ownership (control of) this can be cash, goods, intangiables, etc. More assets is better than less assets but in order to attain all those assets no one generally pays upfront, they more than likely borrowed money on the way.

The Liabilities portion of the other side represents all the borrowing I've done on the way to attain all these assets, and these assets will later on have to be used to pay these liabilities. Liabilities are not flexible, if I borrow 1000 dollars I must pay back 1000 dollars. So since liabilities are not flexible having large liabilities make the company less flexible during decreases in the amount or value of their assets.

After using my assets to pay off all these liabilities the remaining quanity is my Equity (true ownership), this quanity is flexible so more equity is desireable. A company that is almost all equity is Apple and they have proven to be a company constantly innovating in bad and good economies due to their capital structure aka balance sheet.

So more equity is desireable and less liabilities as well... so how does this relate to the economy as a whole. The Assets/ Resources in the Economy is like the assets side of the balance sheet, a bigger economy is more desireable than a smaller economy but what is the makeup of that economy can differ.

The Public Sector is like liabilities, rigid and not very flexible. Wages in the public sector only go up and never go down, instead of adjusting expenses the public sector will tax more to make up short fall. So this portion of our economy lacks the resiliency to withstand reduction of assets in the economy, so the larger this portion of the economy the more difficult the down turn.

The Private Sector is like Equity, it's flexible, entrepneurs can adjust their costs, wages, and everything in order to survive a downturn in the economy without having to waste more resources, the private sector can adjust to shifting assets/resources in the economy.

Conclusions:

- To have a resilient economy a larger private sector is desireable which means a smaller public sector, since both sectors are competing over the same resources in the economy.

- When there is a downturn the Public Sector doesn't adjust so it must grab more resources elsewhere, which it will from the private sector which will shrink the private sector which is similar to the effect of a drop in equity when assets depreciate.

Here: Another Great Article Referring to Balance Sheets

The Real Immigration Issue

Being a first generation American I have an appreciation for the immigration issue and it's complexities. Although at the end of the day I feel that many of problems in immigration isn't immigration but the struggle over remaining resource in a economy that is getting weaker and weaker everyday from a growing government. So in a debate at RonPaulForums.com about immigration I had this to say:

Correlation is not causation, there are two main problems economically with
the current state of immigration.

1) The Welfare State - due to having a welfare state
citizens and non-citizens are becoming more and more a drain on taxpaying
citizens and non-citizens... you have to dismantle the welfare system. The
solution to this issue is a supply response, not a demand response. As long as
there is a supply of government services, there will be a demand for it whether
it's domestic or foreign. We must dismantle the supply of government services
which taxpayers must pay for. Volunteered from private sources are encouraged
and a not a drain on those who choose not to volunteer their limited resources.
Also as far as immigration goes, these types of programs attract probably the
wrong people. If you have no welfare system there is no incentive for anyone to
immigrate unless it's to be productive and to have the opportunity to be
productive.

2) Growing Public Sector, Shrinking Private Sector - Due
to unions and a growing state the amount of public sector jobs have increased
which have very rigid wages, they don't go down, and they always go up. This
growing sector has consumed the amount of private sector jobs who have more
elastic wages that can adjust to changes in the supply of labor and demand for
the goods produced. Shrink the public sector, the private sector will grow
enough and be vibrant enough to handle immigration. With the growth in labor
there is a growth in demand for goods to offset it in a healthy free market
economy.

In countries where open borders have had problematic effects have had large
governments and small private sectors. Prosperous countries like Switzerland
have multiple languages spoken. As far as assimilation, culture is constantly
changing on a daily basis, so to argue that there is some constant standard of
values, traditions that hasn't changed in perception or execution is an
idealistic delusion. The beauty of humanity is how it's culture changes one
generation to the next.

None of us talk with a 1920's accent or vocabulary or wear 60's attire
(without a sense of novelty). The world is constantly changing faster and
faster, you either diversify your outlook, knowledge and skills to adapt or get
lost in the changes. It's in this diversity of culture, ideas, and values where
innovation is conjured.