Friday, April 2, 2010

Regulations are very unlikely to reduce financial risk

Chris Dodd's financial reform bill would place severe new restrictions on startups and "angel" investing, and that is a very bad idea, as noted in this article from VentureBeat.

First, Dodd’s bill would require startups raising funding to register with the Securities and Exchange Commission, and then wait 120 days for the SEC to review their filing. A second provision raises the wealth requirements for an “accredited investor” who can invest in startups — if the bill passes, investors would need assets of more than $2.3 million (up from $1 million) or income of more than $450,000 (up from $250,000). The third restriction removes the federal pre-emption allowing angel and venture financing in the United States to follow federal regulations, rather than face different rules between states.

Several investors have written pointed critiques of the bill:

Fred Wilson of Union Square Ventures said startups will be “hit by shrapnel” from the bill. Robert E. Litan of the Kauffman Foundation, which researches entrepreneurship, wrote, “It is difficult to know why these provisions are in a much larger bill whose primary aim is to address the fundamental causes of the recent financial crisis.” Mike Masnick at tech policy site Techdirt described the restrictions as “somewhat horrifying.”
If the point of the bill is to ensure that the hapless public will be spared financial losses thanks to the oversight of government bureaucrats at the SEC, then it is worse than pointless. If bureaucrats could help people avoid risk and at the same time spot the obvious opportunities out there, then why wouldn't we just turn all innovation and risk-taking over to the state? Government was never to intended to protect the private sector from investment risks, and any attempts to do so will only stifle innovation, entrepreneurship and job creation.

As a corollary to this, I doubt very much that Dodd's bill will do anything constructive to limit the risk of future financial catastrophes. If the vast majority of the smart and formerly-rich guys on Wall Street couldn't see the subprime disaster coming, then why would we expect some piece of legislation or some group of regulators to prevent it the next time around? Financial catastrophes are best prevented by strictly limiting the degree to which government interferes in markets. This bill won't do that, unfortunately.

HT: Brian McCarthy and Don Luskin

1 comment:

Benjamin said...

Venture capital investing is a truly stupid area for government regulation. I am appalled at the dimwittedness of this unwarranted intrusion into a sector that has done so much to advance the commercialization of engineering and scientific advances. Millionaires investing in VCs know they are rolling the dice, but are hoping for a big win, or at least to contribute to man's progress.

On the regulation of large banks and hedge funds, I tend to agree with Greenspan and Volcker--no, we cannot see the future, so it makes sense to build some firewalls and dikes, in the form of higher reserve requirement for banks, and collateral requirements for derivatives.

I am not comfortable knowing that an AIG or LTCM can tank and pull down so much with it, unless the feds step in and rescue everybody with hundreds of billions of dollars of taxpayer money,.

The moral hazard part of the equation is not there. Moreover, unless we start throwing money managers into debtors prison, it makes sense for them to leverage to the hilt, and hope for a huge home run.
You bet right leveraged 100-to-1 and you are rich forever, with chateaus filled with big-boobed blondes. You bet wrong, and you go to the next job.