Bubbles and Regulation

Jose D. Roncal

Jose D. Roncal


Our current economic crisis is so deep and complex it’s not likely to right itself anytime soon. How do we work ourselves out of this hole?  Do we need more regulation or less? This is a question that has banks and Wall Street up in arms and one that is plaguing economists and the Washington elite.  

We are dealing with a three-pronged problem: a housing market that bottomed out as the housing bubble burst; a credit crisis, the worst we’ve seen in decades; and now a decline in demand for goods and services and capital investment. Yes, there has been a slight deceleration in the rate of economic decline, but we’d much prefer to be reporting something a bit more optimistic—such as a better-than-slight acceleration.

Few would argue with the fact that things began to unravel at the bursting of the housing bubble, but when you consider the question of whether or not regulation might have prevented this, we have to pause and recognize that markets are inherently bubble-prone.

It’s simple; markets create bubbles. If you need more evidence of this fact, just read our book, “The Big Gamble: Are You Investing or Speculating?”  We’ve written several chapters on the subject of bubbles, citing some of the most notorious bubble fiascos throughout time.  We also outline the warning signs for spotting a bubble in the making and suggest how you can either avoid it or go along for the ride, reap the rewards, and get out before things go awry.

So, if markets create bubbles, would closer scrutiny and stricter regulation prevent such chaos in the future? Who is in charge?  Is some higher governmental agency supposed to accept responsibility for preventing asset bubbles from growing too big . . say, like the Office of Market Bubble Prevention?  Government agencies have been quick to defend themselves against blame by saying that if the markets can’t recognize what’s coming, how can the regulators be expected to? And, of course, they have a point.


Naturally there are a few basic regulations already built in. When you are gambling in the market there are certain restrictions to protect you against self-destruction—there are margin requirements and minimum capital requirements; but even so, the market sometimes has to play a little fast and loose with those rules just to keep up with the shifting moods and emotions of the market.  

It’s true that the job of the regulators is to regulate. But while markets are imperfect, regulators are even more imperfect. In the best-case scenario, they are bureaucratic; in the worst case their decisions can be politically motivated. No matter how you look at it, regulation is a necessary evil, but we think it should be kept to a minimum, even though markets are inherently unstable.

During the Great Depression, we imposed many critical and necessary regulations, both on financial systems and on the real economy. But since then regulation, as well as de-regulation has created headaches.  We allowed investment banks, banks, insurance companies to mingle their operations.  Then we eliminated the Glass-Steagall Act, which had been wisely enacted to prohibit commercial banks from operating as investment banks. The demise of Lehman Bros, among others, stands as a stark reminder of how that all worked out.

The second big mistake was in 1999, when Congress decided against regulating derivatives, in particular credit default swaps. In 2002 those assets totaled around $1 trillion and today they’re worth $33 trillion. What was the fallout of that bad decision? Thousands of mortgages got packaged and sold as mortgage-backed securities and later bundled and sold as a collateral debt obligations. Then thousands of collateral debt obligations were packaged and sold as—nobody knows for sure what to call those; and the whole mess was “insured” by the infamous credit default swaps, which are a part of that $33 trillion we mentioned. It’s a little late now, but does anybody think that a little regulation might have been in order?

Policy makers have tried to convince us that self-regulation is best; by that they mean no regulation. We thought we could count on internal risk management models to keep things in balance; but who was minding the store when the risk takers were raking in all the profits in the banks?  We trusted the rating agencies, but nobody told us that the very same guys that the agencies were supposed to be rating, were also paying the agency to rate them. Where does that leave the whole concept of self-regulation and market discipline?  In the hole.

Yes, there is a need for oversight and regulation. But let’s not forget that which has always been the basis for economic growth. Growth comes from technological innovation and gains in productivity—things that are conceived and birthed in the private sector, not in the halls of government agencies.


What we need now is wiser and more prudent regulation with intelligent oversight of the financial system. Will we find the right balance and get ourselves back on track? As this point, that’s still an open question.

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About the author

José D. Roncal is a truly global executive with over 20 years of experience in international business and finance, having worked and travelled frequently in six continents.