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NEW YORK. – The 2008 financial crisis was a global economic catastrophe that triggered years of new regulations designed to prevent another meltdown. Now that tide of rules is cresting, with officials across the globe talking about pulling back regulations instead of adding new ones. The defenders of the current regime are fighting to save it.

At the heart of the debate are opposing philosophies about free markets, regulation and the role of government. After 2008, the Obama administration in the US pursued an aggressive rule-making path, injecting the government further into bank boardrooms, loan-underwriting decisions and conversations about retirement advice – all in the name of protecting citizens from a financial crisis and risky financial products.

With Republicans in control of the White House and Congress, the U.S. is seeing a resurgence of a different philosophy, one that favours freer markets and is skeptical of Washington’s recent approach to overseeing Wall Street. The government, these critics say, has repeatedly overreached in trying to prevent another crisis. It should take stock of all the work that has been done since the crisis – and consider rolling back many rules that critics say aren’t working as intended or weren’t needed in the first place.

Rein in the banks: the need for discipline

Advocates who support active financial oversight favour an approach that can be summed up this way: Let the markets work, but within significant regulatory constraints to protect society from excesses.

Left to their own devices, financiers can cause a lot of trouble, advocates say. Big banks have incentives to seek short-term profits without regard for the long-term consequences of their actions – and the 2008 crisis provided an example of just how much damage they can do if they succumb to those incentives.

Financial firms and consumers lent or borrowed too much, and regulators failed to act on warning signs before this excessive risk-taking spiralled out of control. Worst of all, the government bailed out some firms because it determined they were “too big to fail” without the financial system imploding. The result was a panic so sweeping, it dried up credit for Main Street and threatened the entire economy.

Regulatory hawks concede that government housing policies may have played some role in inflating the housing bubble but say it wasn’t central to the meltdown. Lack of oversight was. So, they argue, the government has an obligation to protect the economy from risky behaviour – by banning those behaviours entirely or adopting policies that act like a tax on it, making it less attractive in the short term. Financial firms and their customers may have less freedom under these rules, but these advocates say that the effects of those restrictions pale in comparison to the cost of a huge financial crisis.

The 2010 Dodd-Frank law, approved by a Democratic Congress and signed by Democratic President Barack Obama, expanded the government’s power to react to what it viewed as emerging risks in financial markets. Firms considered “systemically important” to the economy now face tougher rules and more intrusive oversight than smaller competitors. A new regulatory committee can designate any firm for these tougher rules.

The idea is that if these firms pose an outsize risk, they should pay for it through higher regulation, even if those rules are complex. Federal Reserve Chairwoman Janet Yellen has said huge banks must “bear the costs that their failure would impose on others.” If the firms don’t like the regulation, so be it, these policy makers say: They can shrink or split themselves apart. Tougher rules have meant that regulators take a far more active role in the continuing management of large firms, and to some extent smaller ones as well. The pro-regulation advocates acknowledge that such involvement might be uncomfortable, but say it’s a lot better than burdening taxpayers in the event of future bailouts.

Take the case of dividends. Large banks can no longer decide on their own to raise the dividend they pay to shareholders. They must get permission from the Federal Reserve first as part of their annual stress tests. The Fed justified the restrictions by pointing out that in the lead-up to the 2008 crisis, big banks paid out capital via dividends, then months later needed capital from taxpayers to stay alive. These restrictions are just one example of the myriad extra rules firms must now keep in mind as they make day-to-day business decisions.

In another case, when financial firms started ramping up a practice bank examiners considered dangerous – “leveraged loans” to companies already deep in debt – regulators at the Fed and the Office of the Comptroller of the Currency responded with prescriptive lending standards that they relentlessly enforced. Critics say the regulators should have let firms make their own lending decisions, but the Fed and Office of the Comptroller say that when a type of lending poses a risk to the broader economy, they have an obligation to try to nip it in the bud.

Backers of an expanded regulatory regime also believe the government has an important role in setting standards for the sale of financial products to limit fraud and deception. Lenders must document a borrower’s ability to repay a mortgage loan, for instance. Under another Obama-era rule, financial advisers must take their clients’ best interest into account when giving advice about investing for retirement.

They also say more needs to be done to improve financial oversight, such as addressing the continued purgatory of Fannie Mae and Freddie Mac, the mortgage firms that are still under government control, and looking for ways to ease the burden of enhanced regulation on community banks.

Those who support a hard line on regulation agree with critics that regulators won’t be able to stop every crisis. But they believe disasters would be more likely if regulators didn’t act strongly when they see budding risks.

Let the market work: complex regulations do more harm than good

Proponents of freer financial markets say the government should let the banks and markets function with limited constraints from bureaucrats. In their view, post-financial-crisis regulations have harmed the broader economy through expensive and unduly restrictive red tape.

Government interference in any industry or market produces unintended consequences, because bureaucrats and regulators don’t have the knowledge that people working in the field do, regulatory critics say. That leads to problems and distortions when the government tries to push an industry to do something to achieve a political goal that’s unrealistic.

The housing bubble was a particularly disastrous example of this kind of meddling, the critics believe. They argue that the government pushed a goal of boosting homeownership through policies that essentially forced banks to take on risky borrowers. Fannie Mae and Freddie Mac lowered their standards, further signalling that lenders should take on low-quality borrowers.

Regulatory critics think the way to head off severe crises is to have fewer rules, not more. Have the government set simple guidelines about what financial firms are allowed to do, and then let the markets decide the rest. Executives will have a natural incentive not to go overboard because they won’t have the government to back them up if they make mistakes — and if they do things that may harm consumers, they will lose business. – WSJ