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Leave Markets Alone


Government intervention only exacerbates the problem.


Editor's Note: The following originally appeared on October 18, 2005 and, in light of current events, has been reprinted here for the benefit of the Minyanville community.

"The view that the consumer is helpless and needs protection by a benevolent government is expressed [by the consumer advisory council]. The view, once widely accepted in this country that competition forces business to serve the public is not even given token nod...The Constitution of the United States was based in part on the belief that people needed protection, primarily from the government, and that free, competitive enterprise was the most efficient engine for promoting the public good.

"At one time, the intellectual climate of this country placed the burden of proof for the necessity of interference with the market process on those who would interfere. Interference was presumed to be an error unless an overwhelming case could be made for it. In the present intellectual climate, the reverse is probably true-actions by the government to regulate business are presumed to be beneficent and the burden of proof is on those who oppose."

James Lorie
Minyanville's Why Wall Street Will Never Be the Same
As we watch Refco open at $1 just 2 months after issuing an IPO at $22, some might say we need more government regulation to solve this problem.

First, let's look at the problem: Each quarter, Refco transferred almost half a billion dollars of debt off its books to a third party in order to make its balance sheet and returns on equity look much better than they really were. Goldman Sachs (GS) and CSFB, the 2 leading underwriters, failed to discover this chicanery; they failed in their fiduciary responsibility. Goldman and CSFB earned over $40 million in fees for their effort, or lack thereof.

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So too little government regulation is the problem, right? I would argue that too much regulation is the problem, for the following reason: Companies are self-serving. They're always going to maximize return (where they fail is in execution or mismanaging risk) - that's something we can depend on. The question is: What's the best way to make sure that they don't do things to harm the system in the process?

I believe that government regulation is the least effective way to do this. Companies don't respect regulation; they're always trying to get around it, and, quite frankly, for every loophole the government plugs, companies find a new one to drill.

The most effective way is for the market to regulate companies. This means customers, suppliers, shareholders, etc. Goldman Sachs is going to do a bang-up job analyzing Refco if they know that their customers will desert them if they fail. They'll be out of business fast.

And by the way, I've heard SEC and private opinion state that underwriters couldn't have caught Refco at their shell game, that if a CEO really wants to hide something they can always get away with it, at least for a long period of time. This is absolute nonsense. Goldman and CSFB merely looked at end of period financial statements in their analysis; by doing that everything looked fine.

But if they really wanted to understand the situation all they had to do is look at the flow of funds and they would find massive amounts of cash and debt being transferred back and forth. For two savvy financial firms this should have been second nature.

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No positions in stocks mentioned.

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