This is the title of a new guest post I wrote for Notes on Liberty, here is an excerpt:
In the UK, there was no government regulation of banking until 1979. Instead, the behavior of banks was subject to tight private regulation. This private regulation of banking was then substituted by government regulation in the 1980s.
I do not want to write a lengthy discussion on the question of which alternative is the least costly in dealing with the incentive problems arising from the implicit subsidy by the taxpayer. There are good reasons to believe an incremental, decentralized and evolutionary system of market-based regulation to be superior to centrally designed government regulation.
But even if this is the case, private regulation arising as a response to the incentive problems resulting from explicit and/or implicit government guarantees is still costly. Indeed, the evolved system of private regulation in the UK banking industry was giving the appearance of a restrictive cartel. If my analysis is correct, this “cartel” served a useful social function, namely to deal with the incentive problems created by the implicit government guarantee. Nevertheless, it also involved costs.
At the root of the problem are the taxpayer guarantees.
There’s much more at the link.