Academic journal article Journal of Corporation Law

Economic Regulation and Democratic Government

Academic journal article Journal of Corporation Law

Economic Regulation and Democratic Government

Article excerpt

Economic Regulation and Democratic Government*


My subject today is economic regulation-why it so often fails in our country, and what those failures should tell us. I suppose it is only fair that I attempt to explain what I mean when I use the word "fail." I really have at least three different things in mind.

The first type of failure is the most obvious one. An economic regulation can fail because it does not accomplish its stated purpose. The medical analogy would be to the doctor who prescribes a course of treatment which fails to cure the patient of his illness.

A second type of failure occurs because the adoption of an economic regulation does not take into account all of the economic effects that regulation may have. Thus, an economic regulation may accomplish its stated purpose, but may have so many reasonably foreseeable and material adverse side effects that, on balance, it may legitimately be seen as a failure. Here the analogy is to the doctor who prescribes a course of treatment which cures the patient of the disease he had, but in addition, and because of the treatment prescribed, causes him some other serious and substantial injury.

At other times, economic regulation fails because it is counterproductive. That is, it not only fails to accomplish its stated purpose but it aggravates the very condition that it was designed to alleviate. This is the doctor who, while trying to cure his patient, succeeds in making his patient's illness worse. Perhaps it would be helpful to give one or two examples of failures of economic regulation, or at least arguable failures, that I have observed at reasonably close range.


My first example comes from the field of securities law. When I was at the Securities and Exchange Commission (the Commission or the SEC) years ago, the Commission was concerned about, among other things, money market mutual funds. The Commission surely had the legal authority to regulate them. The question was: What and how much economic regulation made sense?

It was clear at the time that customers of money market mutual funds were using their money market mutual fund accounts, just as they do now, to write checks in almost precisely the same way they used checking accounts at their local banks. Consumers liked being able to write checks against their money market mutual fund accounts. They also liked the fact that, by and large, they could earn a better rate of return on a money market mutual fund than they could from a checking account at a bank.

There were a number of reasons why money market mutual funds could pay better interest rates than banks on the cash customers deposited with them, such as the fact that money market mutual funds did not have the physical branch systems that burdened banks. More important was that money market mutual funds were not restricted by the complex web of regulations that limited bank profitability. Money market mutual funds, for example, unlike banks, did not have to keep a significant portion of their assets in the form of reserves, which earned a relatively limited return. Money market mutual funds could also invest their customers' deposits in a wider range of financial instruments than banks could. As a result of these and other factors, banks had difficulty competing for customers with money market mutual funds, even though ordinary bank deposits were federally insured and money market mutual fund account balances were not.

I find what the SEC did when confronted with these facts to be interesting. Perhaps simply for reasons of comity within the executive branch, it did not say: "It's time for the banking authorities to reexamine whether all the banking regulations that have the effect of limiting the ability of banks to compete are strictly necessary." Instead, it imposed regulations which effectively limited the ability of money market mutual funds to buy high-yield financial instruments. …

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