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Government regulation of entrepreneurs is both unnecessary and harmful. In a market economy, entrepreneurs strive to gain customers by offering different goods and services. As long as their offerings are consistent with private property, e.g., there is no fraud involved, then the goods and services will be subject to the test of profit and loss. Those that satisfy customers earn profit and survive, those that fail to satisfy customers suffer losses and die out. Customers can appeal to other entrepreneurs to provide expert advise about products too complicated for the non-expert. And this advise can also be tested by success and failure in the market. Government regulation impairs this efficient process of the market and is, therefore, harmful.
The entrepreneurs operating stock exchanges can set their own rules about which trades they allow and which they ban. We would expect that if naked short selling or algorithmic trading were allowed on some exchanges and not others, then customers’ preferences would determine which configuration of allowing and banning was most profitable.
Financial innovations, like derivatives, would also have to pass the market test of profit and loss. As long as no fraud is involved, its efficient for entrepreneurs to offer new financial products and find out if customers prefer them or not. The problems with derivatives in the latest boom-bust have been the result of government regulation. For example, Fannie Mae and Freddie Mac provided support for mortgage-backed securities which then generated a moral hazard for investors.
Here’s a piece by Bob Murphy on the financial crisis. He points out that credit default swaps were a financial innovation to get around government regulation on insurance: