We live in an age of regulation. But surprisingly, there are very few principles of regulation. As Karl Polyanyi said, “Laissez-faire was planned; planning was not.” Planning always seems to be something that arises ad hoc, to address a particular situation, but hangs on and acquires a life (and a bureaucracy) of its own, even after the situation changes. The result is that we are simultaneously over-regulated and under-regulated; we have thousands of pages of regulations that deal with situations that don’t require any, and no regulation in areas that need to be closely watched. The regs raise formidable barriers to competition, as the small businessman often finds that the cost and trouble of dealing with them is an insurmountable barrier to entering a given business. This leaves only the large players, for whom such regulation is a mere nuisance, a cost of doing business that brings a benefit of reduced competition. And since there are fewer competitors, they tend to be more politically powerful, and proceed to capture the very regulatory bodies that are intended to curb them. The government becomes, in effect, the protector of the oligarchs rather than their regulator.Now, on to Aristotle:
And yet, what we have is the exact opposite. Our regulatory system demands stay at home mothers must test their home-made baby bibs and hair bows for lead before sale, but leaves the massive and complex financial institutions that can imperil our economy and country to their own devices, allowing them to issue countless “Liar Loans” and NINJA loans (“No-income, no job or assets”), and limiting them only by their ability to "innovate" new abstract investments and speculative bets.
Aristotle, and the Scholastics who adopted his approach to economics, were surprisingly sophisticated on these topics, while so many Prominent Economists are surprisingly naive. Indeed, Aristotle left us a principle of commerce that serves very well as a principle of regulation. This principle is the distinction he makes between natural and unnatural exchange. Modern commentators, who make no distinctions, have viewed this as a mere primitive hostility to business; actually, it was a shrewd appreciation of commerce. For Aristotle, natural exchange was that which was necessary for the provisioning of the family (the true meaning of economics.) Unnatural exchange that which had only money as it object.
The former is “natural” because it limits itself; that later unnatural because is has no natural limits. For example, a man wishing to buy bread for his family will buy only as much as he needs; this is a natural exchange. But a man wishing only to make money in the bread biz may wish to buy up all the bread and corner the market so as to raise prices and make a fortune on others’ necessities; this is an unnatural exchange. When applied to finance, a transaction is natural when it is when it is firmly and directly tied to the production of some actual product; it is unnatural the more abstract and derivative it becomes, and when its only object is to make money rather than profit from production. Thus, we may say that banks directly financing home purchases or construction are natural transactions, and less natural when they become “securitized,” bundled together and sold in packages to remote investors who will have no contact with the actual homes, banks, or borrowers. The situation becomes even more abstract when you speak of securitizing the securities (“CDO-Squared” or even “CDO-Cubed”) or with CDSs, which become pure speculative bets on the market. The more abstract the instrument, the more closely it should be scrutinized.
Somewhat related, somewhat unrelated - Simon Johnson of Baseline Scenario states in a separate post that "there are simply no social benefits to having banks with over $100 billion in total assets. Think clearly about this – and if you dispute this point, read 13 Bankers; it was written for you." I have not read the book, maybe because I am inclined to agree, but still thought it a challenging statement.