Replacing Knowledge with Power

The problem with the financial products division [of AIG] was not that the regulators were absent or inadequately empowered. The problem was that the regulators, like most regulators, lacked relevant information. They were experts on the politics of the situation, but had no real command of the intricacies of the businesses within their purviews or any stake in the operation.  They were not perhaps as abysmally ignorant about the implications of credit default swaps as regulator-in-chief Ben Bernanke was ignorant about the imperial reach of of the U.S. regulatory state.  But it was a a formidable gap all the same.

Regulation is an effort to replace knowledge with power. The government cannot be sure what complex corporations like AIG are doing.  It does not know how to make AIG better at what it does, how to improve its efficiency and effectiveness as a global insurance company. So it imposes an array of rules that have the effect of distracting the company from its corporate purposes and toward government purposes, making AIG less like an entrepreneurial corporation and more like a government bureaucracy. The rules from outside AIG attempt to substitute for actual knowledge residing within the company about its operations and markets. The vital knowledge in [Hank] Greenberg’s head became particularly unavailable.

From the new edition of Wealth and Poverty by George Gilder.

HKO

Hank Greenberg was ejected as CEO by New York State Attorney General Elliot Spitzer in 2005 over accounting errors amounting to millions of dollars.

Testifying before the Senate Budget Committee in 2009 Bernanke said:

There  was a “huge gap in the regulatory system.”

Again from Gilder’s book,

This was astonishing . How could any gap emerge in regulatory coverage during several decades of expanding the Federal Register by more than ten regulations every day and hundreds of thousands of pages every decade or so in an exponential tide of paper and red tape that could have wrapped and beribboned the entire solar system as a present for the Sierra Club? But Bernanke was clear. “There was no oversight,” he testified to the paragons of oversight on the Senate Budget Committee, “of the financial products division.”

HKO

Adding complex regulation to a system where excessive complexity is already a problem only adds to the possibility of greater systemic errors.  Laws are passed with far greater frequency than the government is able to staff the agencies to effectively understand much less enforce. But the critical point Gilder makes is that the regulators are far more ignorant of the businesses they regulate that the owners. The substitution of power for knowledge creates opportunity for further failures and stagnation and the misallocation of resources.

Incompetence in the private sector will not be solved by greater incompetence in the government sector.