Rise of the Issue
Financial regulation is a set of rules enforced by regulatory agencies, such as the Securities and Exchange Commission (SEC), that financial institutions and companies must follow. These rules exist to prevent the consequences of a poorly regulated financial system, which can have big repercussions on the economy, like was witnessed with the financial crisis of 2008 and its consequences. Regulation tends to increase after large-scale financial disasters, only to be scaled back over time after normalcy returns.
But regulation of financial markets is a very divisive issue, because while some believe it is necessary to protect investors and the economy as a whole, others fear that too much regulation will actually hinder economic growth. When making decisions about regulation, policymakers face a trade-off between increased safety and stability on the one hand, and lower costs of financing and faster economic growth on the other.
The Securities and Exchange Commission is Created
In response to the Great Depression caused by the 1929 stock market crash, the Roosevelt Administration signed legislation creating the SEC in order to regulate markets and protect investors.
World Economy Crippled by Financial Crisis
A worldwide financial crisis occurred in the U.S. by a combination of excessive risk-taking by large financial entities, predatory lending to low-income homebuyers, and the resulting burst of a housing bubble.
Dodd-Frank Bill is Signed
In response to the global financial crisis, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which among many provisions consolidated regulatory agencies, imposed comprehensive regulations on the financial industry, and created the Consumer Financial Protection Bureau.
Archegos Capital Management Defaults on Margin Calls
Heavily exposed by its over-reliance on derivative contracts, the family office overseeing the assets of investor Bill Hwang was forced to default when leading banks made margin calls on their loans.
GameStop Stock is Short Squeezed
Investors lost billions as online gamesmanship by the subreddit “r/wallstreetbets” caused a short squeeze on GameStop stock.
While those in favor believe that adding more regulations ensures the protection of taxpayers, those against argue that it keeps expanding the role and responsibilities of the SEC and other regulatory agencies without increasing their funding, making them less able to keep up and effectively protect investors.
One aspect of the regulations requires companies to keep disclosing more (financial) information, a practice that some believe ensures companies’ compliance with regulations, while others argue that it financially burdens companies with providing information that no one actually reads.
Preventing Future Crises
Proponents of more regulations believe that they make sure that crises like the ones we have seen in the past do not re-occur, opponents argue that regulations do not prevent future crises but instead only ever repair damage once it is already done.
Regulation improves transparency.
Transparency leads to better-informed investors.
Minimum equity requirements protect financial firms and their clients.
Many financial firms failed in 2008 due to insufficient equity holdings.
Regulation lowers the risk for bailouts.
By protecting banks from risks that leave them exposed, regulation preempts the government bailouts.
Taxpayers are protected.
The big bailouts of 2008 were paid for by taxpayers. Regulation lowers the risk of financial failure, thereby protecting taxpayers from further exposure.
“Exotic” investments are discouraged.
Strict financial laws can help stop financial companies from risky, difficult to understand investments.
Regulation incurs costs on the government, therefore the public ultimately foots the bill.
Given the wide variety of financial activities to be regulated, staffing and action by regulatory agencies can be expensive to the taxpayer.
Regulators are always behind.
The financial industry is staffed by clever people whose focus is to find flaws in the financial system they can exploit, while regulators' focus is on finding current breaches in regulation, it makes it hard for them to keep up.
The revolving door may give an advantage to firms.
As with many federal agencies, financial regulation is often staffed with industry veterans who may sympathize with, or be reluctant to investigate, those in their former firms.
Obtaining compliance can be difficult.
Regulation depends on firms' willingness to cooperate. Meeting compliance requirements is a long and costly process for companies.
Loopholes are many and hard to anticipate.
It is difficult to craft rules that cover all the situations they are intended to cover.