Why the FTX meltdown is a lesson in favor of less government regulation

When corporations get in bed with government, everyone loses

We are only just learning about the scale of the FTX meltdown. Recent revelations suggest that the crypto exchange was run like a giant slush fund with money invested being mixed with the company’s own money and used to shore up other companies like Alameda, also founded by Sam Bankman-Fried. The multibillion dollar company also had no accounting department and apparently poor or no records on who actually worked for the company.

In most respects, it seems like a giant con game and even before this it was no secrect that when Bankman-Fried explained how FTX worked with its FTT tokens that it sounded exactly like a Ponzi scheme.

And it was.

Bankman-Fried seems to have managed to get away with this for a long time the way many bankers did before the Great Recession, appearing legitimate. It’s just that in this day and age of code-based financial instruments looking like a computer nerd with unkempt hair and T-shirt and jeans lends one more legitimacy than wearing a suit.

It’s no secret that conservatives are expressing glee at the meltdown since Bankman-Fried was one of the largest supporters of the Democratic party.

But is there a deeper lesson here? Do crypto markets and exchanges need more regulation and oversight to stop people from losing their money?

I’m skeptical of calls for additional regulation of any industry, not because I don’t think they need regulation, but because I am skeptical that government has the ability or the desire to do it.

First of all, any regulation enforcement requires an army of civil servants. Otherwise, pro-government regulation advocates bemoan the lack of resources allocated to agencies. We need more inspectors, more auditors, and more paperwork. So any regulation expands the government’s size as well as the funding allocated to it.

But that must be worth it because what the people are getting is peace of mind that they, e.g., won’t die of contaminated meat or drugs that aren’t what they claim to be.

And they do get that: peace of mind. Yet that peace of mind may have little more value than the FTX Tokens. Its only value is what people think it has.

A recent Reuters article shows how FTX sought to be seen as the most regulated crypto exchange in what has become a supposedly underregulated industry.

It’s no secret why corporations seek regulation. It’s not because of any philanthropic desire. By seeking regulations, corporations are able to write their own versus when they wait until some disaster strikes.

Even if disaster strikes, industries help create regulations are porous, often written with numerous loopholes that allow them to continue the dangerous practices under different names.

Far from being a counterbalance to corporate overreach, the government is a tool that corporations use to increase their profits and avoid market competition.

Even when government regulations have positive intentions to help consumers, they often backfire. A good example is the 80/20 rule in the Affordable Care Act (Obamacare) that forces insurance companies to spend 80% of their premiums on healthcare and the remaining 20% to themselves. This rule gave insurance companies an incentive to pay as much as possible for healthcare because their 20% take could be much larger. If insurance companies were regulated by free markets, instead of government rules, they might be forced to split the premium pie with health care providers.

Some of the ACA was intended to increase market competition, such as requiring heath care providers to expose their pricing. Hospitals have naturally been extremely slow to comply with this provision, implemented at the start of this year, while other healthcare provides like ambulatory surgical centers have been more willing.

You have to ask why market forces didn’t force hospitals to be transparent about their prices in the first place. A big reason for this is that hospital pricing is notoriously complex and impossible for the ordinary consumer to understand. This is the biggest reason why hospitals have been slow to comply despite Northside Hospital in Atlanta being slapped with a $1 million fine for their failure.

Medical billing is a lot like getting a car or home repair done. You may get an initial estimate but depending on what happens the bill may be vastly more than you were originally quoted.

In other words, price transparency regulation is inherently flawed because patients won’t know what they are going to pay based on a pricing list.

Yet, home and car repair companies do seem to compete with one another, and market forces apply much more strongly than to the medical industry. Part of the reason is because the barriers to entry in those industries is relatively small. You have far more options and you can shop around for quotes. But there is a deeper problem.

Why can’t you shop around for quotes about a medical procedure too? Well, you can and in fact insurance companies often do this with pre-authorizations and negotiated prices. Hence, the insurance company shops around for you.

But this doesn’t work that well, however, if you can’t choose your insurer since your insurer is only too happy to pass costs on to you.

Ultimately, this means that the invisible hand of the free market cannot regulate health care prices because they are insulated from the consumer by the industry’s collusion both with government and employers.

In fact, Milton Friedman argued that the United States government, via the tax code, created this monster:

No third party is involved when we shop at a supermarket. We pay the supermarket clerk directly: the same for gasoline for our car, clothes for our back, and so on down the line. Why, by contrast, are most medical payments made by third parties? The answer for the United States begins with the fact that medical care expenditures are exempt from the income tax if, and only if, medical care is provided by the employer. If an employee pays directly for medical care, the expenditure comes out of the employee’s after-tax income. If the employer pays for the employee’s medical care, the expenditure is treated as a tax-deductible expense for the employer and is not included as part of the employee’s income subject to income tax. That strong incentive explains why most consumers get their medical care through their employers or their spouses’ or their parents’ employer.

While Health Savings Accounts have alleviated some of this burden, they are too little too late to kill the beast that is American healthcare.

This shows how interference in the free market, whether it comes from government or the industry itself, tends to distort prices and hurt people in the process.

With the meltdown of FTX, the market is correcting itself, and the government does have a role in holding those who perpetrated the fraud accountable, but it is a lesson that we should always be wary of industries funding politicians and seeking government regulation. They do not do so out of philanthropic desires but only out of greed. While in some sense greed is the motivating force of much of our economy, it has no place in government.