Jennifer Schulp from the Cato Institute on Financial Services and Regulation
In a recent episode of Capital Ideas, Nick Morgan and Dara Albright of the Investor Choice Advocates Network (ICAN) welcomed Jennifer Schulp, Director of Financial Regulation Studies at the Cato Institute. Schulp, co-author of Financing Opportunity: How Financial Markets Have Fueled American Prosperity for More Than Two Centuries, shared insights into the pivotal role that financial markets play in driving innovation, economic growth, and individual opportunity.
Capital Markets: The Engine of Growth
Schulp emphasized that capital markets are foundational to economic progress, facilitating the efficient allocation of resources. Without them, growth and innovation would be stunted. “Functioning markets provide the ability for us to move capital to its best uses,” she explained. Whether it’s investing in a friend’s idea, contributing to public stock markets, or launching a new business, markets empower individuals and institutions to take calculated risks for potential rewards.
The pooling of resources through capital markets enables investments at scale, allowing innovation to flourish. Schulp noted that markets are uniquely suited to bringing together diverse participants who don’t necessarily know each other, creating a collective environment where risk-taking can lead to widespread prosperity.
Risk: A Necessity, Not a Dirty Word
While “risk” is often portrayed negatively, Schulp argued it is an integral component of progress. “Risk is often the price we pay for bigger rewards,” she said, underscoring the inseparable link between risk and reward. Regulation that seeks to shield investors from loss often stifles the very opportunities that foster growth and wealth creation.
Protecting individuals from risk may seem benevolent, but Schulp cautioned that it also limits their exposure to upside potential. This tradeoff, she said, is rarely part of the public discourse. Importantly, she stressed that not all risks are suitable for all investors, making diversity in risk tolerance a strength of the market system.
Albright connected this point to the broader American ethos, noting that the country itself was built on the willingness to take risks. From early settlers to modern entrepreneurs, risk-taking has been a defining characteristic of American success.
The Myth of Regulation as a Stabilizer
A misconception exists that increased financial regulation leads to greater market stability. Schulp dismantled this notion, citing historical evidence to argue that U.S. financial markets have remained crisis-prone despite an ever-growing regulatory framework. “American history has proven that we’ve become no less crisis-prone as we’ve added regulation after regulation,” she stated.
She highlighted the 2008 financial crisis as an example, challenging the common narrative that deregulation was the root cause. Instead, she pointed to systemic issues and regulatory missteps that exacerbated the crisis. According to Schulp, a heavily regulated market often becomes less resilient because participants are forced into uniform behavior to comply with regulations, reducing the diversity that makes markets adaptable.
Secondary Markets: The Unsung Heroes
The conversation also explored the critical yet often underappreciated role of secondary markets. These markets, where investors buy and sell securities from each other rather than directly from issuers, are sometimes dismissed as non-value-creating. Schulp firmly rebutted this criticism, asserting that secondary markets are essential for price discovery and liquidity.
“Without secondary markets, you don’t really have a functioning primary market,” she argued. The ability to exit an investment is what makes the initial decision to invest less daunting, encouraging more participation and capital formation. Moreover, secondary markets help establish fair market prices, a key challenge in areas like private equity.
Balancing Regulation and Freedom
Reflecting on the regulatory landscape, Schulp acknowledged that while some oversight is necessary, overregulation can suppress innovation and dynamism. She noted that much of the financial regulation introduced since the Great Depression was based on misconceptions about market behavior.
For example, she highlighted the creation of the SEC in the 1930s, often justified as a remedy for the speculation-driven market crash of 1929. However, Schulp pointed out that the actual causes of the crash—such as excessive margin buying and economic imbalances—were unrelated to speculation. “Speculation plays a vital role in markets,” she asserted, cautioning against regulatory efforts to arbitrarily define and curb it.
Looking Back, Moving Forward
One of the strengths of Schulp’s book, as noted by Morgan, is its historical perspective. By tracing the evolution of financial markets from America’s founding to the present, Schulp and her co-author offer a nuanced understanding of how markets operate and why they matter. From Alexander Hamilton’s financial innovations to modern debates about regulation, the book serves as a reminder that many of today’s challenges are rooted in enduring principles.
Final Thoughts
Schulp’s insights underscore the importance of functioning markets, measured regulation, and the acceptance of risk as a driver of growth. Her call for greater appreciation of secondary markets and skepticism of overregulation resonates across political and economic divides.
As Morgan concluded, “Less regulated markets are more resilient.” By fostering diverse, flexible markets, the U.S. can continue to be a global leader in innovation and economic opportunity.
For those seeking a deeper dive into these topics, Financing Opportunity is a must-read. Its blend of historical analysis, policy critique, and practical insights makes it an invaluable resource for investors, policymakers, and anyone interested in the future of financial markets.
Nick Morgan is President and Founder of ICAN, the Investor Choice Advocates Network, a nonprofit public interest litigation organization dedicated to serving as a legal advocate and voice for everyday investors and entrepreneurs. He was previously a partner in the Investigations and White Collar Defense Group at Paul Hastings law firm. Morgan also previously served as Senior Trial Counsel in the SEC’s Division of Enforcement.