A few months ago, in the heat of debate over the JOBS Act in Congress, I penned an in-depth critique of the portion of the JOBS Act seeking to legalize crowdfunding in the United States. As I argued, the version of the JOBS Act initially approved by a bipartisan majority in the House of Representatives was a brash experiment in targeted radical deregulation of financial markets that would have come on the heels of one of the worst economic disasters in American history — itself attributable to deregulation with inadequate oversight — while the asthmatic U.S. economic recovery continued to wheeze and stumble through the smoldering wreckage of once-mighty financial institutions.
As background, JOBS Act-style crowdfunding legislation — which would more properly be dubbed “crowd investing” or “equity crowdfunding” to differentiate it from other models such as Kickstarter, a funding platform for creative projects — is a form of market deregulation aimed exclusively at investors who by definition have assets or income placing them squarely in the middle class and are making investments so small that in reality they have neither the leverage nor the economic incentive to demand adequate disclosure by issuers. As I wrote previously, an economics professor could hardly dream up a better textbook example of market failure for a final exam.
In a world populated by human beings rather than saints, this dismal outcome is not merely possible; it is inevitable, a classic “race to the bottom” propelled by the invisible hand of profit maximization. A confidence crisis created by widespread losses and disillusionment among investors can cause catastrophic market collapse (as seen in 1929), with protracted macroeconomic misery until that confidence is restored. It’s no coincidence that Congress passed the Securities Act in 1933 and the Securities Exchange Act in 1934. Crowdfunding in its purest form would shred both of those laws under the presumed theory that if the amounts invested are small enough, it simply doesn’t matter if individuals choose to gamble in a wholly unregulated market.Continue Reading