The Price of Financial "Safety"

Bureaucrats can't protect anybody.

For anyone who owns a financial investment - which is to say, any American with savings or a pension of any kind - hardly a day goes by without becoming palpably poorer.  The Obama bear market continues to tear through the nest eggs of rich and poor alike; nobody, not even Warren Buffett, is immune.

Human beings hate to lose something; it's in our nature and always has been.  The Christian New Testament tells a story about a widow who lost a coin, and diligently swept and searched her entire house until she found it.

Research has demonstrated that people are far, far more disheartened about losing money they already possess than they are about failing to receive money they never actually had; in the scientific literature, this is known as "loss aversion bias."  Wise investors will watch out for illogical behavior in their own investment choices and try to avoid it.

Unfortunately, the world is full of unwise investors - and they vote.  It should come as no surprise that, as Newsday reports:

Investors could get the same kind of protection that buyers of toasters and toys get from the Consumer Product Safety Commission under legislation that Sens. Charles Schumer and Dick Durbin (D-Ill.) plan to introduce in the next week.

The bill would create a Financial Product Safety Commission that would review and approve financial products and services to ensure they are not scams, like the Bernie Madoff Ponzi scheme that allegedly bilked investors of an estimated $50 billion.

"Consumers deserve to have somebody on their side ... a regulator that will review financial products and services to ensure they work, without any hidden dangers or unreasonable tricks," Schumer said at a Senate Banking Committee hearing Tuesday.  [emphasis added]

This sounds like a good idea, does it not?  Thousands of Americans were out-and-out robbed by the criminal behavior of Bernie Madoff, Dennis Kozlowski, and other infamous "malefactors of great wealth."  The primary purpose of the government is to protect the innocent; isn't it the very job of the government to stop financial fraud in its tracks?

Can Government Stop Fraud?

Before assigning a role to anyone or anything though, it's smart to sit down and consider whether the proposed entity can actually do the job.  The track record of the government is, let us say, not entirely unblemished in this regard.

The New York Times tells us that many banks are finding the government bailout to be such a bad deal that they're trying to return the money they were given.  Bernie Madoff was a thief and a liar - yet a whistleblower sounded the alarm for nine years, and the SEC did not even bother to investigate his now-amply-proven charges.

Is there a lesson to be learned here?  According to the Washington Post:

Experts say the Madoff case may simply point to the inherent limits of regulation.

"The SEC going back to its formation, and the Justice Department going back to its formation, are never adequate to crime at its time. It's simplistic to look back and say that this was the SEC's fault," said former SEC chairman Arthur Levitt, who knew Madoff when both worked on Wall Street and consulted with him while at the SEC. "A very skillful criminal can almost always outfox the regulator or the overseer."  [emphasis added]

The very wisest minds in finance, in whose best interest it is to keep the economy both running and trusted, are of the opinion that it is not possible for regulators to catch every fraud, and we are foolish to expect them to.

Shouldn't we at least try?  After all, we trust in the Consumer Product Safety Commission to keep us safe from deadly toasters and toys; why can't we trust a Financial Products Safety Commission to do the same in the financial world?

Good question!  So let's take a look at the Consumer Product Safety Commission; the comparison is enlightening.

Can Government Keep Toys Safe?

We hardly need to review the countless failures of the CPSC to protect the American people from poisonous Chinese toys; ten seconds of Googling will tell you more than you ever wanted to know.  The reaction of Congress to these failures of the CPSC is precisely the same as that of Sen. Schumer to the financial frauds: we need stricter rules and more intrusive regulation!

Fortunately for us, the Chinese toy scare happened some time before the financial collapse; Congress' response is much further along, so we can see how it turned out.

And oh boy, how it ever turned out!  Frightened of lead in toys?  No problem: it's now illegal to use lead of any kind in any part of anything that children might ever use, even if it's completely inside the object where it cannot be reached.

With the stroke of a pen, all childrens' ATVs and other motorized equipment are instantly banned - because by the nature of chemistry and engineering, motor-vehicle batteries contain lead.  Now, if your kid is eating an ATV battery, lead poisoning is the least of your worries, but far be it from Congress to apply logic.

It gets worse.  The law provides for million-dollar penalties not just to manufacturers, but to sellers of any children's items containing lead no matter when it was manufactured.  Up until 1985, colored book inks... contained lead.

No points for guessing what's now happening in libraries and used bookstores all across the country.  From Missouri to Washington, any books older than 1985 - those classic Little Golden Books, Richard Scarry stories, the gorgeous art-books of Bill Peet , even H.A. Rey's Curious George - are being yanked from the shelves, and in some cases thrown in the trash as hazardous waste.

As written, the language would give libraries the option of testing older editions for lead, which would cost between $300 and $600 per book, Sheketoff said. "Libraries can't afford that," she said. "So libraries would have to risk $100,000 fines, remove children's books or bar children from coming so they're not breaking the law. Once you lay it out like that, you realize how ridiculous this is."  Most books printed before 1985 are no longer in circulation at the Daniel Boone Regional Library, Director Melissa Carr said.

Again, if your kid is literally eating books, you have worse problems than lead poisoning.  So to solve a non-problem, we destroy our entire history of children's culture?

Conspiracy theorists no doubt have realized that 1985 is just about when political correctness began to permeate children's literature and the old, timeless themes were swept aside.  Coincidence?  Quoth the City Journal:

There was no time to waste in putting this advice into practice. A commenter at Etsy, the large handicrafts and vintage-goods site, observed how things worked at one store:

"I just came back from my local thrift store with tears in my eyes! I watched as boxes and boxes of children's books were thrown into the garbage! Today was the deadline and I just can't believe it! Every book they had on the shelves prior to 1985 was destroyed! I managed to grab a 1967 edition of "The Outsiders" from the top of the box, but so many!"

Faced with a literary holocaust like this, it seems trivial to complain that the same thing is happening to all sorts of used clothing, at precisely the time when American families are struggling and desperately need to be able to buy used clothing cheaply from Goodwill and the Salvation Army.  But to the shivering unemployed, they're more likely to be glad to warm themselves at the bonfire of burning books since the two-dollar coat they could have bought is already off to the landfill.

A Nation of Book-Burners

Let's review: an idiotic overreaction has led to the destruction of hundreds of millions of dollars' worth of valuable merchandise, eminently usable and useful, for no perceptible increase in safety, and at the destruction of the value and livelihoods of a vast number of American small businessmen to say nothing of history and culture.  This, in an area where we can clearly see the cost: anyone can observe the books and clothes being yanked from the shelves and hauled away.

Nobody, though, can see the financial products not developed, the improvements in efficiency not made, the great enterprises not formed, because of Schumer's new requirement to get a bureaucrat's stamp of approval before doing anything.  Are bureaucrats known for their knowledge of finance?  If they were, they wouldn't be bureaucrats, now would they - they'd be working on Wall Street for ten times the salary, plus bonus.

His FPSC is no less than lowest-common-denominator innovation: the smartest among us are forbidden from doing anything the stupidest government troll cannot understand.  Osama bin Laden himself could not concoct a plan more certain to utterly destroy the American economy, the American dream, and the American way of life.

Criminals and fraudsters should pay the price for their crimes, doing hard time in the federal pen.  It's a national disgrace that Bernie Madoff was allowed to luxuriate in his million-dollar penthouse while those he robbed clean toilets - though we can't help but notice that Sen. Schumer accepted some of Madoff's ill-gotten gains.

Our wise Ben Franklin famously advised that we can't find safety by giving up essential liberties.  This saying is usually applied to national security; it's just as true in the world of finance.

How has the United States reached such pinnacles of wealth, except precisely by innovation and good old fashioned American ingenuity?  Regulatory interference is the death knell of innovation, our primary source of riches.

Senator Schumer is looking in the wrong place to find either the culprit or the solution: instead of the offices of Wall Street for the culprit, he needs to look in the mirror; and instead of a Washington bureau for the solution, he needs to take a look at the Bill of Rights.

Or he could look at a movie screen.  No less a legend than Dr. Henry Jones, Sr. has trenchant advice for anyone who thinks government can bring us safety and success through regulatory power:

Morons like yourself should try reading books instead of burning them.

Petrarch is a contributing editor for Scragged.  Read other articles by Petrarch or other articles on Economics.
Reader Comments
It is wrong to lump Dennis Kozlowski with Bernard Madoff as you did in your article. Dennis Kozlowski was convicted of taking unauthorized bonuses of 150 million dollars (even while his company owed him much more in deferred compensation), paid the money back, in addition to a fine of 170 million dollars which went to the City and people of New York. Tyco, the company he worked at for more than 27 years never went out of business and remains strong today. No lost pensions or jobs. Please tell me how that compares to Bernard Madoff's 50 billion dollar Ponzi scheme? A better reporter would have found a legitimate comparison like maybe Ken Lay, who's actions actually did cause the closure of Enron and the loss of thousands of jobs and pensions. I have several friends who lost everything because of Madoff. To compare what he did to Kozlowski diminishes the impact of Madoff's crime and is blatantly unfair to Kozlowski.
March 19, 2009 12:51 PM
I agree with jflicker. I was going to mention that earlier after reading this, but forgot about it. It's unfair to lump Kozlowski and Madoff together, in any sense. Madoff's intent from the beginning was to defraud others and he destroyed thousands of lives. It's debateable whether Kozlowksi did any damage at all.
March 19, 2009 1:26 PM
The point was not to compare their crimes, the point was that government is inherently incapable of finding out about EITHER sort of activity before the fact.

Cops can't prevent crime and don't really try, their job is to sweep up the mess after a crime has been committed and hopefully apprehend and incarcerate the miscreant.

If we lock down our financial system so tight that crime can't happen, profits and investment won't either. That's the point.
March 19, 2009 1:38 PM
Great article, I do think that you missed one important point. The money was in a hedge fund. Hedge funds are designed to work more or less like black boxes. The whole point of a hedge fund was that it wasn't well regulated. Yes, the SEC should have figured out that it was fraudulent in its many investigations but the people that invested their money knew that they were limiting regulation to thereby increase possible returns.

Investments other than Hedge funds are already regulated quite enough. People that don't want to deal with regulations possibly cutting into returns can't really complain when regulations fail to protect them.
March 19, 2009 6:14 PM
Dennis Kozlowski was indeed a criminal; among other things, he defrauded on sales tax.

However, you're all quite right that his crimes are nothing compared to Madoff's, and as Julia pointed out, that's precisely the point: our laws are so complex that they are more of a "gotcha" nature. If the government decides to do you in, they can find Some Way to do it; if the government likes you, you can do anything and get away with it, as with Obama's cabinet of 40 thieves. Which is the opposite of a justice system, it is institutionalized injustice.

Our problem, plain and simple, is a government that wants its hands in everything. As Reagan said, "Government is not the solution to our problems; government IS the problem." Yet opinion leaders of today, insist on looking to the government for solutions when the government has never solved anything and never will; and the voters keep going along with it.

The "robber barons" of the 1800s committed all manner of what would now be horrific crimes; even by the standards of the day, they were pretty immoral. But they actually did accomplish something useful for the nation, building our national railroad infrastructure that built America's wealth and industry for a century. They are a good example of how capitalism is supposed to work: harnessing the natural greed and venality of humankind so that, even when they are behaving in an excessively greedy way, they still can't help but benefit society even while helping themselves.

Our system clearly doesn't work that way anymore, as we see from the rogues and thieves whom we can hardly tell from the productive but unlucky, and with whom it is difficult to distinguish those that did something useful and those that did not. Government is manifestly incapable of accurately making those judgements; if we ask it to try, we should not be surprised when things get even worse.
March 19, 2009 8:48 PM
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