The Regulatory Cure Far Worse Than The Illness

Jonathan Hoenig
Don’t Tread on Me!

Thanks to the NASDAQ collapse, the Enron scandal and plenty of trend pieces in the New York Times, a small minority of fraudsters has put lawmakers on a path of overzealous regulation and thus, economic stagnation. Shortly put, the regulatory “cure" is far worse than the illness itself.

An unregulated market doesn’t mean anarchy. Corporations, just like individuals, are expected to operate under the rule of law and are punished if they violate anyone’s rights. In an unregulated market, companies are innocent until proven guilty. Regulators, however, hold that companies are guilty until they prove themselves innocent, either by paying fees, complying with red tape or altering their businesses to fit a bureaucrat’s whim.

Regulation punishes innocent businesses. It holds them to completely arbitrary standards, set not by the marketplace but by an unelected pseudo-lawmaker who is often totally ignorant to industry practice. And because regulators’ whims can shift like a weathervane, corporations become fearful of long-range planning and investment. Rightly so, they’re unsure if their acquisition plans or business model will be the next target of the “public servants” who are so apt at making up the rules as they go along.

Although few politicians understand the cost of regulation, it quickly becomes a major burden that makes business more expensive and less dynamic. Just look to the U.S. capital markets, where, in recent months, many foreign businesses have stopped listing their stocks on U.S. exchanges simply because the bureaucratic cost of regulation has grown too large. Dozens of small U.S. companies have gone private, unable to afford the Orwellian oversight of newly passed securities legislation.

The biggest joke is the suggestion that more regulation will increase market confidence. In an unregulated economy, a company will seek to earn investor trust by providing comprehensive, transparent and honest accounts of their business and financial condition. Auditors would compete to provide the highest quality accountability of financial statements.

Onerous government regulation, however, has lessened the need for companies to establish a sound reputation among investors and analysts. Public companies fulfill the SEC-prescribed minimum disclosure requirements, but have no incentive — only increased risk — to provide any deeper level of disclosure. You’ll recall that Enron, WorldCom and every other massive fraud in recent years took place within highly regulated organizations. It is because they fulfilled the minimum regulatory requirements that auditors weren’t pressed to dig deeper into their financials.

There will always be a few bad apples in every batch. But in a free market, that fact doesn’t spoil the stew. What does, however, is the regulatory burden that condemns all business as guilty before a crime is even committed. As long as bureaucrats set the rules, economic innovation, productivity and achievement will suffer.

This weekend our Business Block has much more on how government regulation affects YOUR investments. Tune in Saturday 10am — noon ET.

Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC and is a markets columnist for He appears regularly on FNC's business program Cashin' In.