Raghuram Rajan, governor of the reserve bank of India argued how the financial crises came to happen. Among other things, he explained the financial crisis through analysing the macro environment including the impact regulations had. There are many regulations that hinder companies to prosper and sometimes whole systems need to be adapted to allow the business to continue functioning. Companies in over-regulated industries, for instance the petroleum industry with its 25,000 filed restrictions, might start to focus more on the regulators than on customer needs. This blog post focuses specifically on regulators and whether their extensive regulations should be reconsidered.
When considering policies such as the Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, which absorbs risks of housing mortgages, one can argue that policy regulators have good intentions. Through Fannie Mae regulators wanted to provide a fund that helps civilians to become house owners but the consequence of providing civilians mortgages without any financial checks was profound, since most mortgages could not be paid back. One could argue that regulators created the fundament for the financial crisis.
If the economy would have to self-regulate itself without the help of regulators, would the so-called invisible hand regulate the market? Some economists favour the idea of letting the market regulate itself whereas others argue that companies would create cartels and create barriers for other companies that are not part of it. One might assume that companies would most likely create cartels because of two reasons: 1. Companies aspire to create monopolies together with other specific companies because of the possibility to attain cost advantages over non-cartel members and 2. Companies would not have to innovate to become more competitive against each other, which could save further costs and motive to create cartels.
On the other hand, how would an economy respond if regulators would not guide it? What would happen in moments of recessions? Without a force that stimulates the economy one could foresee a reduction in consumer confidence, which again would strengthen the recession and maybe even lead to another great depression. So, are regulations necessary? Perhaps yes. However, one has to keep in mind that regulations themselves can cause whole industries to fall into a recession. After the financial crisis the so-called Dodd-Frank with 848 pages came into action. Many regulations of Dodd-Frank are incorporated by now into the law and many more are about to become incorporated. This costs the financial industry its profitability. New regulations are trimming the financial industry’s profit margin according to a colleague of mine who works at the Deutsche Bank as a Risk Manager. Other companies that want to enter the financial industry with innovative ideas first have to overcome the burden of understanding the industry regulations. That is the point when regulators become more important than their actual cause. Regulations should lead industries in an appropriate direction but not hinder companies to perform successfully within the industry. It is a fine line but a distinguishable one.
If companies would have to regulate themselves, then they could lower current working standards. Will the rest of the society hinder companies to lower working standards? At the end, companies are only as strong as its workforce. If activists, aware civilians, and employees would choose to rebel against lower working standards one could argue that regulations would not be needed. After all, the society would regulate companies. However, living in a society in which apathy seems to be the norm one has to question whether society would intervene when required.
After having argued for and against abandoning regulations, the conclusion is that is not wise to let industries regulate themselves because society as a whole cannot cope without guidance. On the other side, it neither makes sense when regulators become more important than their actual cause, which is to guide industries and not to hinder them from performing successfully.