Laissez-Faire Capitalism can’t fail before we try it.

I’ve never felt inferior because I earned my MBA from a school ranked lower than 13th. This Forbes essay by Nouriel Roubini, a professor of economics at NYU’s Stern Business School, reminds me to continue that confidence. After a rundown of recent economic facts, Professor Roubini states:

This severe economic and financial crisis is now also leading to a severe backlash against financial globalization, free trade and the free-market economic model.

I’ll interrupt here to say that I agree with this statement, although those lashing out are ignorant of what they rebuke. That includes Professor Roubini, who next states:

To paraphrase Churchill, capitalist market economies open to trade and financial flows may be the worst economic regime–apart from the alternatives. However, while this crisis does not imply the end of market-economy capitalism, it has shown the failure of a particular model of capitalism. Namely, the laissez-faire, unregulated (or aggressively deregulated), Wild West model of free market capitalism with lack of prudential regulation, supervision of financial markets and proper provision of public goods by governments.

I have two words for Professor Roubini: Sarbanes-Oxley.

Having Enron and WorldCom go bankrupt, with the accompanying loss of shareholder investment, is the free market. Having executives go to jail is regulation. As a libertarian I am not reflexively against regulations that make the market more transparent. Regulations have unintended, often negative consequences, as Professor Roubini quickly glosses over, yet I don’t consider the idea of the SEC an abomination. But to pretend that we are in some Wild West model of capitalism suggests two conclusions: Either Professor Roubini is incompetent, or he’s engaging in hyperbolic nonsense bordering on propaganda.

I’m betting on the latter:

It is clear that the Anglo-Saxon model of supervision and regulation of the financial system has failed. It relied on several factors: self-regulation that, in effect, meant no regulation; market discipline that does not exist when there is euphoria and irrational exuberance; and internal risk-management models that fail because, as a former chief executive of Citigroup put it, when the music is playing, you’ve got to stand up and dance.

The “Anglo-Saxon” model of supervision and regulation is hardly self-regulation. If the free market has failed, how can we explain the massive unwinding of the complex, poorly designed mortgage securitization market? People who invested unwisely and often ignorantly are being punished through the loss of their wealth. Does Professor Roubini believe the mortgage securitization will reappear anytime soon without new regulations to control it? Pain is a powerful motivator. The market is working exactly as it should be, except Congress and the President are determined to reduce the pain of those who made mistakes, intentional and unintentional. Incentives matter. Regulation skews incentives. We ignore that at our own peril.

Going back to Sarbanes-Oxley (SOX), I deal with it as a financial software consultant. It drives me insane with the ridiculousness it requires. It is a burden with very little obvious benefit. Every decision we make must run through the SOX team. Every mistake must be documented in detail to verify that it was an honest mistake rather than an attempt at deception. Something as trivial as having extra, unintended access to the financial system must be documented in detail beyond the logs clearly showing the user ID never accessed the system. It’s a Chicken Little response that makes politicians feel proud for Doing Something, but the regulation actively diminishes productivity. And it assumes every accountant is a criminal.

Our modern day Wild West exists only in the halls of Congress.