Some basic rules for financial regulation

  

From an old article in the Institutional investors by John Liew of AQR, there is a good list of what government regulation should and should not do with respect to finance. I agree with this list and would be happy to add to it, if there is something missing. 

• The government should recognize that bubbles can happen. It is rare, but the cost of a bubble is high and should be addressed prior to the peak. 

• The government should not subsidize or penalize some activities over others. Picking winners and losers should not be the role of the government even if other country may have a different view.
• The government should not promise to eliminate the downside. Capitalism is about winning and losing.
• The government should encourage disciplining mechanisms like short-selling (and conversely, it shouldn’t ban or penalize them). Markets need short-seller to keep the markets honest.
• The government should encourage, not tax, liquidity provision. Liquidity is critical for the pricing of markets and regulation to reduce it will have strong negative effects. 
• The government should punish true fraud harshly. Fraud creates a lack of trust. Trust is critical for market success.
• The government should have consistent laws consistently applied (for example, when it comes to bankruptcy). Consistency is critical if long-term investment decisions are to be made.

• The government and self-regulatory bodies should encourage consistent and reasonable accounting. Accounting is the lifeblood of market information.
• The government should encourage that financial institutions mark more things to market.  Book value accounting masks mistakes.