QUESTION
I am a former employee of a lender whose president is a hard-core hater of the CFPB. He believes that our government is out of control and the CFPB has been overreaching for years. He is glad that the CFPB is being shut down. I was a paralegal in the legal department. After having to put up with his railing and cursing about the government in general and the CFPB in particular, I decided to resign. Since then, I have been with a law firm and continue to attend law school.
It's not as if his mortgage company has been in trouble with the CFPB. It complies with all the rules and regulations, and every audit by states and the CFPB itself has shown that the company complies adequately. There have been no administrative actions or fines.
From what I can tell, the CFPB is a kind of anti-scam police. They are also involved in protecting consumers' financial interests with respect to financial products and services. I can't figure out why this is such a bad thing that it should be destroyed. I thought regulating on behalf of consumers is what good government is supposed to do. We can debate what overreach and unnecessary regulations are, but destroying the agency that actually helps consumers seems really dangerous.
My former boss takes the position that any government involvement in the free market is an attack on free enterprise, which to him means running his business the way he wants to run it. And, any agency, like the CFPB, that regulates his company is an attack on its survival. I think that's really very extreme. I got tired of trying to convince him otherwise.
I know this is controversial. I want to widen the lens a bit. You have always been willing to discuss controversial subjects. My former president reads every post you've written for years. I'm sure he will recognize me as the questioner, though I didn't tell you his name or company name. It may bother him that I am writing to you. Fortunately, I am no longer an employee.
He often discusses your views and interpretations of the law. I have subscribed for years. I think you are a reliable resource for regulatory guidance. I want to know your view. It would really help!
Is government involvement in free markets justifiable?
COMPLIANCE SOLUTION
RESPONSE
I respond to controversial subjects as they may relate to many aspects of regulatory compliance. I make no apologies. I know they are controversial because we predictably get a small tranche of unsubscribes whenever I discuss a topic that bugs the unsubscribers. Sometimes, the unsubscribers write to me, and we have enjoyable correspondence.
We offer this newsletter as a labor of love. It's free! All are welcome. However, I discuss the regulatory landscape with all its ups and downs, controversies, and wrangling, and always try to ensure that compliance with the law is clarified. My goal is to educate and offer some helpful guidance.
Anyone who does not recognize that the government partners with markets, be it mortgage or any other economic market, exhibits a view that borders on willful ignorance. I have taught graduate classes on market action relating to mortgage origination, and one obvious factor we discuss is the "free market" concept, which is the thesis that markets should not allow government involvement (often framed as "government interference").
"Free market" lingo wears several masks, such as "free trade" and "free enterprise," but the notion that any economic market is free of government involvement is belied by the fact that the government must be involved in ensuring and monitoring its legal and regulatory framework.
Now, for a dose of reality:
There has never been a free market in the history of the world.
Never. Nowhere. Not now. Not ever.
The concept indirectly stems from an economic theory called "laissez-faire" – which, in French, means "allow to do" – which is a financial concept that purports to inform free markets and capitalism. In that scenario, the government does not regulate business, taxes, or tariffs. Instead, it proposes that a market self-regulates through the economic mechanism of supply and demand of products and services. And, it asserts that individuals drive markets through self-interest, which, somehow, leads to social and economic benefits.
There are economists of certain schools who reframe laissez-faire as a "hands-off" approach to market activity. The motto: Let the chips fall where they may, irrespective of the outcome, because, magically, it will all work out for the better!
The attempt at minimal government intervention historically and economically leads, among other things, to income inequality and the lack of protection for workers (i.e., the middle class). In that sense, the free market theory is, by extension, a tool of class warfare. Sure, laissez-faire can promote economic growth, but it can also exacerbate social problems.
Can you guess when laissez-faire was most prominent in the United States? The answer is it was most notable as a policy during the Gilded Age, the age of the Robber Barons, in the late 19th and early 20th centuries. These days, three individuals collectively are worth more than the bottom half of the population of our country.[i] This inequality is obviously not sustainable. Clearly, free market thinking is utopian thinking but does not pertain to human action.
In terms of economic theory, a hypothetical free market leads to monopolies. For instance, a successful supplier tends to get bigger and more powerful. It then buys up smaller competitors or puts them out of business. This tendency is an evolution toward monopoly. Therefore, what might seem to be a theory that can favor small businesses is actually one that destroys them. This is the case in many markets, and governments have had to put in place regulations to avoid monopolistic and predatory practices.
You might have heard of another utopian economic theory called the “Invisible Hand.” This is a term coined by Adam Smith, the Scottish economist.[ii] It is another way of suggesting that when individuals act in their self-interest within a free market, it naturally leads to the best possible outcome for society as a whole, as if guided by an unseen force, promoting efficient allocation of resources – without the need for government intervention. Essentially, the pursuit of personal gain can benefit the broader economy through competition and market dynamics. Cynically, it means that greed drives actors to beneficial behavior.
Many a person who uses the “Invisible Hand” theory to justify removing regulations simply does not understand or has never read Adam Smith. Smith favored less government intervention because he thought that there could be possible benefits in the future if there were less government involvement in trade. However, Smith himself once described "invisible hand" as a style suitable for unscientific discussion, and, importantly, he never used it to refer to any general principle of economics. His argument against government interventions in markets was based on specific cases and particular markets but it was not absolute.[iii] In fact, Smith referred to an invisible hand, never the invisible hand (which tends to hypostatize it, making it seem like an actual force of nature).
All markets arise within a governmental framework. Whether they occur in a tropical or subtropical savanna, a nomadic desert tribe, an ancient agora, or Wall Street, a governmental socioeconomic structure of some kind underlies and buttresses every market. Markets can harm and fail a country. Government can mitigate these extremes by restoring essential values to benefit all citizens. It does this by means of regulations.
Individualism and small government may be one aspect of our consensus reality; however, democracy and those living in a democracy have common interests that are equally important. Despite the complexity of markets, government plays a fundamental role in promoting economic prosperity, protecting people, and providing an economic safety net. The interests of business enterprises are not necessarily congruent with the needs of society.
As an example, society has a vested interest in preserving its natural resources. However, an unregulated free market would take no consideration of the effects on the environment or limitations caused by the depletion of natural resources necessary for market growth. Think of it as similar to what happened to the whaling and sealing industry. When sealing and whaling in the sub-Antarctic islands took place in the period from the late 19th to early 20th century, populations of seals and whales were destroyed by hunting of seals and whales. Ultimately, this led to the businesses destroying themselves.
By the term "overreach," I assume your former employer wants a market-government mix that has a higher percentage devoted to unrestrained market activity and a lower percentage devoted to governmental activity. Striking the best balance is a constant challenge, and the balance varies (or should vary) based on the specific market affected. Some markets require a higher regulatory activity, and some markets require a lower regulatory activity. All markets require regulatory activity, more or less. No market anywhere in the world can ever be free of regulatory activity.
I have spoken to CEOs who truly hate regulations with a passion. They view regulations as their enemy. But when I pose specific questions to them, every one of them backs off. Most of them – but not all! – want the consumer protected and safe from bad actors in a market. Generally, governmental regulations are legally binding. Broadly speaking, regulations are rules by the government to control activities, one of which is economic markets. One such market involves the origination of mortgages from point of sale to securitization and beyond.
Regulations affect all markets in one way or another. The goal is to be proactive in ways to support acceptable human behavior, often based on society having become reactive to unacceptable human behavior. For instance, there are financial regulations that protect consumers from financial fraud. The huge amount of financial fraud in mortgage markets leads to higher loan origination costs caused by early payment defaults, indemnifications, money laundering, and substantial legal risks.
The reality is that the government and markets together have built the United States.
In effect, we cannot have one without the other.
Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
[i] The 3 Richest Americans Hold More Wealth Than Bottom 50% Of The Country, Study Finds, Kirsch, Noah, Forbes, November 9, 2017
[ii] The Wealth of Nations, Smith, Adam. “Invisible hand” was used only once in his Wealth of Nations, when arguing that governments do not normally need to force international traders to invest in their own home country.
[iii] Indeed, the term “invisible hand” is used once in Smith’s Theory of Moral Sentiments when discussing a hypothetical example of wealth being concentrated in the hands of one person, who wastes his wealth, but thereby employs others.
