The Invisible hand of the market vs. the very visibile and heavy hand of legislators and lobbyists...

Charles,

Thank you. I agree that laws, police, and courts are necessary and desired to enforce contracts and protect property rights. Absolutely. We might call these "negative individual rights," as they protect individuals from the use of force or fraud against them - they negate the use of force or fraud against others - while otherwise leaving them free to pursue their happiness as they see fit. The US constitution, as becomes obvious when you read it, was built specifically to legitimate governmental power to protect these negative individual rights, and virtually nothing else.

That said, I think there is a critical difference between preventing fraud and preventing people from participating in financial instruments they may or may not understand. To call these instruments "secret" markets is, I propose, misleading.  Imperfect knowledge is a key dynamic of all financial instruments, some more than others. That's why they have variable risk and variable returns. That is the nature of the game. Play at your own risk.

Like buying stock in Enron, it is the duty of the investor to understand the business they are investing in. Those who risk investing in untested/non-sensical business models (Enron), investors (Madoff), or investment vehicles (credit default swaps, currency leveraging, etc.) that they do not understand, are rolling the dice and risk losing their investment. That is the nature of financial markets.

**I think the greater danger is the source of our current problem: Partial regulation of markets gives investors the illusion that they are protected, when they are absolutely not protected. **

This illusion leads to disillusionment in the system when they find they aren't, whether that is Smoot-Hawley, Bretton Woods, price and wage controls, S&L, Long Term Capital, Enron, or AIG. The more we foster the illusion, the more people MISUNDERSTAND the risk involved, and this leads to leveraged/unbalanced investments.

End result equation: More regulation --> more illusion of protection --> more risky investing --> more leverage/imbalance --> worse crash (when it comes, as it always does - water finds its own level, and trying to regulate that "level" is fighting reality/nature - and it's not smart/nice to fool with Mother Nature.)

That is the point of my original post on the invisible hand. You cannot regulate financial markets sufficiently to eliminate (or even significantly reduce) these kinds of risk, because 1) the players in those market will ALWAYS be more nimble than the regulators, and 2) regulatory capture (corruption and insular thinking) will ALWAYS distort the regulatory process towards greater leverage and greater disaster.

Remember, the instruments that "broke" the system were sanctioned and authorized by the regulatory bodies in question. They were not "adequately regulated" by those bodies, certainly! Again, they NEVER are! But they were under their legal jurisdiction. They were "approved" instruments. THAT is why everyone invested in them, even regulated banks!

In other words, the market was under the illusion that they had been vetted as legitimate instruments. THAT is the problem. The SEC, in virtually all cases, offers the illusion of protection and legitmacy, but does not (and I asssert CANNOT) have the insight, power, or manpower to actually police the instruments under their "watch." They create the illusion of order and precision, when financial markets are really the wild, wild, wicked west. Forget credit default swaps - think basic accounting practices! Anyone who studies the financial markets in any depths quickly realizes it is jungle of mirrors, not well ordered cubicles. But the SEC and other regulators make it seem logical, ordered, safe. That is an illusion, and it leads to false security in our securities.

The illusion of being able to steer markets. The illusion of being able to control risk. The illusion of being able to create a system so secure that human beings cannot game it. The illusion of being able to create a government that is big enough to provide "positive" rights (health care, education, day care, elder care, etc.) but not so big that we can still control the military-industrial-cogressional-corporate welfare-special interests-social justice complex that it fosters/incents/legitimizes. The illusion that we can give ever-increasing power to a central authority while protecting ourselves from being crushed by its weight.

So, like all theoretical ideas, I think the idea of using "judicious" state power to prevent and punish "abuse" of financial instruments is laudable. However, it neglects the insights of the invisible hand.

1) individuals know what is best for themselves becuase they have local knowledge, and can change course in an instant, while non-local planning intentionally blurs/averages or ignores/fights local knowledge and loses flexibility in proportion to the bureacracy implementing it.
2) regulations lead to regulatory capture, abuse, corruption, and institutional/systemic problems.
3) false trust in regulation leads to overly risky choices, less personal responsibility, and leveraged systems that collapse on themselves when the "truth/reality" of the underlying system can no longer support the leveraged system.
4) The more the system collapses, the more "regulations" are created to "solve" the "problems" that were created by regulations, racheting up the "judicious" power of the state. See my post on The Road To Serfdom.
http://integrallife.com/member/gameofthriving/blog/road-serfdom-and-collective-aversion-sophisticated-regulation

Warmly to you as well!

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