How many times have you heard the call for deregulation in the name of free markets?

But does deregulation make any sense when it comes to our financial markets?  In Transparency Games, I answer with an emphatic NO!

Why did I respond this way?

I call the financial markets of the 1920s and earlier the time of “free” financial markets.  Government involvement in these markets was minimal.

This lack of involvement was justified under the assumption investors acted according to the principle of buyer beware (caveat emptor).  Under this principle, investors were suppose to protect themselves.  An example of how investors were suppose to protect themselves was they would demand sufficient disclosure so they could assess the risk of any investment and know what they owned.

Did minimal government involvement work?  NO!

Financial markets were prone to financial crises driven by panics (think bank runs) and market crashes (think 1929 stock market).  Financial crises had significant negative impacts on the real economy.

Policymakers recognized the need to redesign the financial markets so they would better serve the public interest.  Regulation played a key role in this redesign.  I call the financial markets from the 1930s to the 1970s the time of “regulated” financial markets.

Nowhere was this “regulation” more apparent than in the government mandating disclosure so investors could assess the risk of an investment and know what they own.

Did government involvement work?  YES!

The redesigned financial markets didn’t have panics or market crashes.

The era of “regulated” financial markets gave way to the era of “deregulating” financial markets.  Beginning in the 1980s, policymakers set about “deregulating” the financial markets.

Nowhere was this “deregulation” more apparent than in the setting of disclosure requirements.  In the regulated era, government was an advocate for investors.  In the deregulated era, government ceased being an advocate as this conflicted with treating Wall Street as a client.

Did deregulation and the movement back to the “free” market era work?  If reintroducing financial crises meant it worked, then yes.  The partially deregulated financial markets suffered a global financial crisis that began on August 9, 2007.

If continuing to prevent financial crises meant it didn’t work, then NO!

Since the acute phase of the financial crisis, we have seen the introduction of a blizzard of new regulations.  They amount to much ado about nothing.

I say this because these new regulations didn’t address how to prevent a financial crisis.  Nowhere in these new regulations is the need for disclosure so investors can assess the risk of any investment and know what they own addressed.  Nowhere in these new regulations does the government cease treating Wall Street as a client.

The Transparency Label Initiative was introduced to address the need for preventing a financial crisis.  The label serves as a reminder to investors to limit their exposure to investments valued solely on the basis of an unconfirmed story told by Wall Street and concentrate their investments where they can Trust, but Verify the story.