There's a really quite interesting and provocative analysis of hedge fund regulation posted at the CLS blog by Jeremy Kidd of Mercer University’s Walter F. George School of Law:
In 1999, Bruce Yandle, emeritus dean and professor of economics at Clemson University, proposed a public-choice economics version of the old saying, “politics makes strange bedfellows.”[2] It was called the Bootleggers and Baptists Theory. He argued that lasting regulations require the cooperation of two groups: the so-called Baptists, who provide vocal, morality-based policy arguments in favor of the regulations, and the bootleggers, who provide the money necessary to enact and defend the regulations. The name comes from the coalition that supported bans on the sale of alcohol on Sunday—Baptists because they believed it immoral to drink on the Sabbath, bootleggers because the bans limited competition and increased their profits—but the principle applies to a broad range of regulatory issues. In fact, once one grasps the principles of the theory, it becomes difficult to ignore evidence of bootleggers everywhere.
The formula is simple: government regulation that achieves its stated goals poorly, if at all, combined with benefits for competitors of the regulated entity. A good example could be the regulation of hedge funds under Dodd-Frank,
In the wake of the financial meltdown of 2008 to 2009, there was no shortage of Baptists arguing that something had to be done to minimize systemic risk, largely by reforming the market structures that were believed to have contributed to a dangerous accumulation of risk. ...
Who are the bootleggers ...? Two possibilities seem plausible. One is large, traditional financial institutions. The investment vehicles provided by traditional firms are rough substitutes for the services of hedge funds. They are likely to be less risky but also offer lower returns. If regulations lower hedge fund returns, traditional investments with their lower risk become attractive again. The other, related possibility is larger hedge funds that wish to limit competition from smaller rivals.
I am really looking forward to reading the underlying paper. On a quick glance, it seems like a potentially powerful extension and interstitial enhancement of Roberta Romano's analysis of SIX as quack corporate governance and my analysis of Dodd-Frank as the same. Indeed, I view it as highly complementary by providing an alternative explanation for why the rules Dodd-Frank developed were so badly designed and providing an elaboration on my argument that Dodd-Frank was motivated by interest groups with something other than the public interest in mind. RECOMMENDED
