Updated: Nov 23, 2020
The role of financial services regulation is to define and clearly communicate free market guard rails. Defining the risk playing field and allowing FSs to operate, innovate, and thrive within the playing field.
The tragedy of the commons occurs when the playing field is not well defined. Essentially, when regulators are not doing their job.
It is human nature to exploit poorly defined or weakly enforced regulation. Denying the likelihood of exploitation is akin to denying our very nature.
The role of the regulator is to recommend and sometimes create appropriate regulation (creation authority depends on whether legislative action is required) and to enforce regulation. Unfortunately, enforcement can be dependent on budgets, skills of examiners, political enforcement posture, etc. A sad reality is the enforcement posture lessens as the economy improves and Bezzle inventory increases. Just when a pro cyclical increase in enforcement should be occurring.
In Chernow's Hamilton, he writes:
“As chief agent of a market economy, he (Hamilton) had to spur acquisitive impulses, accepting self-interest as the mainspring of economic action.”
“Self-interest” relates to Adam Smith and de Tocqueville’s writing on “enlightened self interest.” The practical and worldly experience of Hamilton may have caused him to doubt the extent to which people are “enlightened” when it comes to their own self interest.
The beauty of capitalism is its attempt to utilize the energy of our human impulses, namely, fear and greed. Then, using guardrails, in the form of laws and regulation, to guide the energy. This was very different from other socio-economic systems that attempt to directly control human impulses through totalitarian command. (Monarchy or socialism)
"He hoped businessmen would have a broader awareness and embrace the common good. But he was so often worried about abuses committed against the rich that he sometimes minimized the skulduggery that might be committed by the rich. The saga of William Duer exposed a distinct limitation in Hamilton’s political vision."
- Ron Chernow, Alexander Hamilton
Enlightened self interest works more effectively with mechanisms to define the playing field and associated accountabilities for all stakeholders of the enlightenment. (Stakeholders such as the owner / shareholder, employee, customer, and community). In the very young United States of the 1790s, the regulatory guard rails did not yet exist. Rightfully, Hamilton was more concerned with building rather than regulating.
Perhaps the invisible hand works better in a legal framework, to help harness human “Animal Spirits.” John Maynard Keynes would have been a good addition to Hamilton in the 1790s. Too bad he wasn’t born yet!