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Stop The Reform-Industrial Complex!

By Jerry Bowyer - January 9, 2009 12:00 AM

Yesterday former SEC Chairman Arthur Levitt published a piece in the Wall Street Journal calling for more regulators as a response to the Madoff scandal.

Amazing! This regulator, who approved Bernie Madoff to head Nasdaq and put him on a reform commission associated with the Securities and Exchange Commission (SEC), now tells us that he was right all along and we need more regulators. Others have called for higher pay for regulators, or more power for regulators, or more independence for regulators from our elected representatives.

Am I the only guy in America who thinks that the Madoff scandal should discredit the regulatory state, rather than lead to an expansion of it?

Levitt was the chief cheerleader of what Larry Kudlow calls the "goo-goo" good government crowd--Financial Division. Did that stop Madoff? Heck no! Madoff was a big player in that crowd. Close to Levitt and other financial scolds, Madoff threw loads of money at Democrats who sat on regulatory oversight committees. Levitt even said that Madoff's niece married an SEC official.

Economist Joseph Schumpeter--the "creative destruction" guy--formulated another highly insightful economic principle called "the capture theory."

Schumpeter said that regulatory bodies that are created to control a specific industry will eventually be captured by the industry they're supposed to be regulating. The revolving doors, the overlapping social spheres, the pure intensity of incentive that comes when a group of individuals get to control the business dealings of another group of individuals--all of these add up to a situation in which greater regulation makes the system less honest.

More regulation means less transparency, integrity and stability. The larger the government, the greater the incentive to for special interest groups to capture control of it. Corruption is directly proportional to the size of government. This is just basic public choice theory.

The thing is this brand of good government doesn't work. Did Sarbox decrease market volatility? Did McCain-Feingold take the money out of politics? No and no.

The "reform" movement has become a status factory for special interests, and a haven for those most in need of public relations points. Illinois Gov. Rod Blagojevich ran as a reformer. Obama's "non-partisan" health care "reform" bill in the state senate gave Blago more power. George Soros--convicted of insider trading by the French government--has given so much money to the reform-industrial-complex that almost no one knows about his conviction. When John McCain got in trouble as part of the Keating Five, how did he respond? He became a reformer. He turned away from his free-market roots and took up campaign finance "reform"--that is, regulation. Enron's Ken Lay was known as one of the most vocal proponents of ethics in the corporate board room.

Of course these men I've listed do not all have the same need for rehabilitation. Whatever the level of cleaning needed, reform has become a sort of financial Lourdes bath. You go there to be washed clean, at least on the outside.

Redemption is offered to rapacious practicing capitalists who shut down textile factories--like Berkshire Hathaway (nyse: BRK - news - people )--or hedge fund managers who collapse national currencies, so long as they are willing to decry unfettered capitalism and confess to the creeds of the moment: expensing stock options, mark-to-market accounting, no carried interest treatment, campaign finance reform, etc.

The crooks, of course, don't look like Irwin Mainway, the evil toy manufacturer on Saturday Night Live. They don't wear $50 suits, grease their hair back and shrug compulsively as they defend the new Invisible Pedestrian Halloween costume. You can't just spot them as bad guys on the street.

The big crooks look great. They get as close as they can to prestigious institutions. They'll ingratiate themselves into elite liberal circles. They'll do their best to find seats on the boards of directors of museums and institutions of higher learning. And, yes, they will frequently be heard uttering the word "reform."

Jerry Bowyer is chief economist of Benchmark Financial Network and a CNBC contributor.
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