Most anti-speculation measures don’t work. Smart speculators figure out ways around them. However, occasionally, as with the 1720 Bubble Act and the 1933 Glass-Steagall Act, they work too well, killing off markets altogether. Better for government to be ineffectual than lethal.
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Speculative excesses such as those during the late 1920s or the recent credit bubble naturally bring demands for reform after the burst. Sometimes the reform is harmless but ineffectual. The “uptick” rule, in effect from 1938 to 2007, appears to have had little effect on short-selling patterns. The Securities and Exchange Commission concluded that it “modestly reduced liquidity and does not appear necessary to prevent manipulation”.
But occasionally, regulation can be too effective. During the first stock market speculative euphoria, the 1720 South Sea Bubble, the government introduced a Bubble Act, requiring all new company formations to obtain a Royal Charter. This Act remained in force until 1825; it prevented further stock market bubbles for a century, but is generally held to have delayed the Industrial Revolution by several decades.
The Glass-Steagall Act attacked speculation by separating commercial and investment banking. This forced investment banks to spin themselves off from their commercial banking parents and operate on very thin capital, since outside capital was scarce. This sharply limited securities underwriting capacity, resulting in a collapse in corporate debt and equity issuance.
Whereas $3 billion of corporate securities had been issued in the pre-boom year of 1924, and $8 billion in 1929, the new issue market took decades to recover from its 1933 nadir, so that the highest issue volume reached before 1945 was a mere $1.2 billion in 1937. The scarcity of new capital undoubtedly prolonged the Great Depression.
Regulators fail because speculators are nimble, intelligent and highly motivated to find ways around restrictions. Only truly draconian measures can foil speculators’ activities, but since legislators lack market expertise, such measures are generally over-broad and therefore destructive to the markets.
Recent anti-speculative moves, the ban on short-selling financial companies and New York’s attempt to make credit derivatives sellers obtain insurance licenses, probably fall into the “ineffective” rather than the “lethal” category. One hopes so, anyway.