Take a basic course on economics and you'll learn about the central role of information in markets. When both parties have perfect information, markets function perfectly. When one side has more information that the other, inefficiencies develop. If the asymmetry is bad enough, you get a market failure, the result of which is a suboptimal outcome for both the market participants and for society as a whole.
Keep that in mind as you read this most excellent post from Ezra on problems with the mortgage lending industry:
But whether it was the loan officer pushing the borrower off the variable-rate cliff or the borrower begging for a bit more rope with which to hang herself or, most likely, a bit of both, doesn't much matter. It is perfectly well understood that borrowers, by and large, know nothing of loans. It's a market that operates with a huge asymmetry of information. And though we know that loan officers are, in fact, loan salesmen, they are not presented that way -- instead, they're offered up as helpful experts waiting to guide you to a safe and secure financial solution. They're presented, in other words, like loan doctors.What's supposed to govern their behavior isn't merely basic morals and business ethics, but a sense of concern for their company. If too many individuals enter into loans they can't afford, defaults will rise and the bank will suffer. Which is exactly what's happened. The loan officers, and above them, the banks, and above them, the regulators, were the ones with the knowledge, power, and authority to head off this mess. This market works, it exists, because we trust them to run it in such a way that does not massively exploit the ignorance of individuals, and does not put the entire economy at risk. They failed. But, unlike with the individual borrowers, they failed when their whole mission in life was to not fail, when they were paid to have the tools and information to not fail, and now, in reconstructing this market, we need to figure out what regulations will keep them from failing again. The behavior of the borrowers, financially stupid though it may have been, is simply not equivalent. This whole banking superstructure has supposedly evolved to help them -- to suddenly turn and say that it was a self-interested enterprise they had to outthink the whole time is quite strange.
This is precisely right. We know that average borrowers cannot possibly know everything they need to know about mortgages in advance of their need to apply for one. And as a result, we have constructed a system that requires the people who are selling the loans to provide such information. That system exists because of regulation, and if it has failed, it means that either that the regulations were not being followed or that they need to be reworked.
This same lesson can be applied to a wide variety of regulatory circumstances. No matter how badly people at CATO might wish otherwise, modern markets don't spontaneously generate and operate on their own. Our society has simply grown far too complex for that. Without regulation, most markets will fail, and if the market is big enough (think mortgages) those failures could have catastrophic consequences for all of society - even for those who were not active participants in the market at all. To put it in economic terms, our markets have grown so complex that the markets themselves produce externalities.
As a result, it is in everyone's best interest - and by everyone I mean both businesses and consumers - for us to construct an intelligent and efficient set of rules and regulations to guide and shape complex markets. We know with absolute certainty that information asymmetries will exist. Basic economic theory doesn't just suggest this - it practically demands it. Therefore, the choice often isn't if we should regulate but how.
Don't believe me? OK. Then try try... private property rights are the foundation upon which all markets are built. First comes the rights, then comes the markets. And where do the rights come from? And how are they enforced? Regulation. Even John Locke - Mr. "God gave me the ability to create private property, but government allows me to protect it" - understood this. So why oh why is it still so hard for so many people to see?
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