Eric Falkenstein makes a powerful argument against government regulation of financial markets. No matter how the politicians try to gussy it up, when regulators talk about setting “capital requirements,” they’re really talking about government bureaucracies pricing risk. It is foolishness to believe that bureaucrats can price risk better than a rationally self-interested market player:
…lets say you have two swaps, but they both offset each other almost exactly for interest rate risk, but as they have different counterparties, they have differing credit risk. How about swaps from the same counterparty, but differing interest rate exposures, partially netted. How much should capital be netted? And if the US banks have capital requirements greater than economically necessary, how many seconds before all swaps would move offshore?
If something is too complicated for the market, it goes double for government. And as finance is really about contracts, ideas, it doesn’t have to put up with heavy handed regulation, especially when New York is not the origin of the capital (we aren’t capital suppliers). London, Hong Kong, or Tokyo would be glad to pick up the slack.
Remember Sarbanes-Oxley? It actually hurt “little guys” by driving up compliance costs, and it convinced foreign investors that London was a better place to invest capital and list IPOs, resulting in London overtaking the Big Apple as the world’s financial capital. You can’t legislate away the business cycle.
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