There have been two recent developments in the business world that bring to the fore the question of the government's role in markets. In the first, Net Neutrality, Comcast was found to have been slowing the traffic on one specific type of traffic, and it was ruled the FCC did not have a right to step in and prevent Comcast from manipulating traffic on its networks. In the second, Goldman Sachs collaborated with Paulson & Co., a hedge fund, to create a synthetic CDO and then take the short position on it. Where Goldman ran afoul was not in conspiring to create a rotten product, nor paying a rating agency to give it an AAA rating, but rather misrepresenting Paulson's role in the product to its customers. Both cut to the heart of the government's role in free markets and regulation in general. Examining each case is instructive to evaluate the government's role in free markets. In this brief, we take neither side, but allow the reader to decide on their own.

In the first case, the Associated Press, in late 2007, reported that Comcast was slowing BitTorrent and some other traffic without telling its customers. BitTorrent is a so-called "peer-to-peer" program that allows users to share large files. When someone loads the BitTorrent software and downloads a file, it makes that and other BitTorrent files on the computer available to other users to be downloaded. As you might expect, BitTorrent is a favorite for downloading illegal copies of music and movies, but also has other legitimate uses. When downloading a file, large amounts of traffic are being downloaded and uploaded, since your computer becomes a server for others in the peer-to-peer network. This consumes the bandwidth of the overall network, and, according to Comcast, can clog the traffic of all users. Consumer rights groups Public Knowledge and Free Press, along with online video distributor Vuze, filed complaints with the FCC. Comcast initially denied the charges, then Comcast said it throttled peer-to-peer traffic only during times of peak congestion, but studies from the FCC and the Max Planck Institute for Software Systems in Germany contended that Comcast slowed BitTorrent traffic around the clock.

FCC lawyers argued that its net neutrality decision was "reasonably ancillary" to the agency's enforcement of several of its responsibilities under the Communications Act, the 1934 law giving the FCC its primary authority. However, Judge Tatel wrote in the majority opinion, "The Commission has failed to make that showing. It relies principally on several Congressional statements of policy, but under Supreme Court and D.C. Circuit case law statements of policy, by themselves, do not create 'statutorily mandated responsibilities.'" It does appear possible that the FCC could begin a proceeding that would reclassify broadband carriers as so-called common carriers, which are regulated more heavily than the current classification of information provider. So although Comcast won this case, the FCC does appear to have the power to reclassify the internet and take a greater role in regulating it. The business question at hand is: should the FCC regulate the carriers or allow free markets to work?

On one side are the large service providers such as Google and the consumer rights groups who believe that internet traffic should not be subject to interference by the carriers. The fear is that that Comcast and other Internet Service Providers (ISPs) will start charging companies to allow their websites to be accessed from their network. For example, Comcast might offer to only allow one search provider, Microsoft's Bing, Yahoo, or Google to run over their network. The highest bidder would get the right to have their search engine available and all others would be blocked. In a less extreme case, the internet providers could simply slow the traffic of service providers unless they paid a "tax" to the ISP. If it took a minute or so for your Google page to load, you might be tempted to use Bing or Yahoo, which loaded immediately. Another option would be for Verizon or Comcast, which provide voice-over-IP (VOIP) phone services to block independent VOIP venders such as Vonage. Is this simply good business sense or stifling competition and abusing their role as owners of the utility? Finally, there is the specter of China-type censorship. Since the ISPs are looking at every packet of information and deciding what should be passed on, slowed, or blocked, there is the possibility of censoring information on some criteria other than economic interests.

On the other side of the argument are the free market types, who believe that since Comcast or other ISP internet providers spend billions creating a network, especially difficult for the laying cable for the "last mile" where neighborhoods have to be hooked up to the network, they should have the right to do whatever is in their own best economic interest. They believe that it would not be in the ISPs economic interest to block or slow certain traffic. In most areas there are at least two network providers (perhaps over phone lines and via the cable company), and they would lose customers if they did so. As evidence, ISPs could put caps on the volume of traffic consumed, with higher tariffs for users that exceed these caps. However, this is hugely unpopular. If you buy some software online, attend a video conference, and then play an on-line game, you could easily exceed this cap in a very legitimate way without even knowing it. Perhaps there is a market for discounted, or even free, internet service if the ISP is able to shift some or all of the cost from the consumer to the content providers. After all, Microsoft, Yahoo, and Google are making a ton of money, which wouldn’t be possible without the ISP infrastructure. Shouldn’t they share in the costs?

In the second case, the SEC filed civil charges against Goldman Sachs. For those less versed in the case, it instructive to understand a commodities future contract, a type of derivative since this financial instrument derives it price from an actual commodity. Using a cotton future as an example, a farmer might buy a short position (right to sell X pounds of cotton, protecting him or herself from a price decrease when his actual crop comes to market) and Levis-Strauss might buy a long position (agreeing to buy and receive delivery of cotton at a set price - meaning that he or she is trying to profit from an anticipated future price increase) with an expiration date of October and a strike price of 50 cents a pound. This is good for the farmer, who has high fixed costs and knows ahead of time that between the future and the sale of his crop on the spot market he'll get a certain amount of income for his crop. This is also good for Levis-Strauss who can predict raw material in their pricing models. Should the price of cotton be 55 cents at settlement, the farmer left money on the table, and should it be 45 cents, Levis will have overpaid by a nickel. Each of these losses or gains would offset the actual cost of the underlying commodity, in this case cotton. But taking this uncertainty out is worth it to both parties.

Futures do provide a valuable role above and beyond speculation or hedging, providing price discovery of a commodity. It should be noted that most future contracts don't involve the physical delivery of product, rather two investors merely taking the opposite sides of a trade. It would be easy to say that derivatives that don't involve delivery of the physical product should be outlawed, but they can provide value. Suppose you sell flags via a catalog. Since you have no idea how many flags you'll sell in a particular quarter, after all periodically something happens and a wave of patriotism sweeps the country, so you buy your material on the spot market, paying the going price for materials whenever you run low. Since you sell via a catalog, you don't have much flexibility in pricing, and a major run-up in the cost of materials can eat up your profit margins. To counter this, you could take the farmer's position in a cotton future. If you bought 100,000 of these contracts and the price of cotton raises to 60 cents, you'd get $10,000, which could be used to offset the additional cost of the cloth used in the flags. If it fell to 40 cents, you'd have to pay $10,000, but would be making it up by paying less for raw materials and therefore making a higher profit. This reduces risk and evens out your profits.

In the case of Paulson & Co., in 2007 they saw the bubble in the housing market and began to bet big that there would be a correction. They bought every Credit Default Swap and short position they could. When they wanted to buy more, they went to Goldman Sachs who told them they had no short positions to sell. This is when they decided to manufacture some short positions in Collateralized Debt Obligations (CDOs). A CDO is the right to a stream of payments of any type debt, in this case, mortgage payments. Goldman and Paulson created synthetic CDO, a derivative product which used options and derived their value based on a basket of existing CDOs. Of course, Paulson picked those CDOs that looked to be the most likely to fail. They then paid the ratings agencies who gave the disaster of a product a triple A credit rating. Finally, Goldman went out and sold these to their clients raking in $15 million in commissions. They did state in the prospectus that a third party management firm had been hired to choose the contents of the product. So far, none of this is illegal. What was illegal is when a Goldman Sachs trader, who dubbed himself "The Fabulous Fab", misrepresented Paulson's position in the product. He claimed Paulson was long on the product, betting that it would rise in value, when, in fact, Paulson was short. When Wall Street was called in front of Congress, emails were exposed that showed the Fabulous Fab and others at Goldman Sachs knew the products were "crap" and that he was selling it to "widows and orphans". Paulson ultimately made $1 billion at the expense of a number of Goldman Sach's clients. This raises a number of interesting questions. Former Fed Chairman Alan Greenspan believed that markets could regulate themselves. According to Greenspan, if there is a lone wolf that would kill and drink the blood of children and orphans, the rest of Wall Street would know it would bring down heat on the entire pack, and would kick the lone wolf out. However, instead of ostracizing such repulsive behavior, the wolf is celebrated as a hero. Such cautionary tales such as Liar's Poker and the movie Wall Street were meant to shine light on this dark, cut throat world of Wall Street where money is the only score keeper and guiding light. Rather being read as cautionary tales, these were considered celebratory tales of daring conquest.

Again, the question is: should it be "buyer beware"? If money is the only way to keep score, and if bankrupting some widows and orphans on Main Street is an acceptable way to get that third vacation home, should Washington use regulation to draw Wall Street a moral compass? What role should the rating agencies play? Would make sense to have any Wall Street firm issue their own rating on any financial instrument they issue? After all, if they know about hidden risk, and fail to account for that in a credit rating, they could be sued for misrepresentation. The complete lack of remorse shown by the Wall Street CEOs in their testimony before Congress was telling. Like an alcoholic coming to an AA meeting drunk, perhaps this was a cry for help. If Wall Street firms are unable to control their excesses, perhaps they need Congress to step in and dictate reform.

It is easy for Conservatives to say that free markets rule and will work themselves out, or for Liberals to insist that unfettered greed has no conscience, but these formulaic responses don’t take into account the nuances of specific cases. As we've mentioned on this site, The-Party-of-Common-Sense.org believes that the government has three roles: to protects its citizens not just against foreign threats, but also against each other; to act as a referee in industry; and for the common good. Should the government step in and regulate the telecommunications industry, or the financial services industry? Should the government step in these industries to protect people from unscrupulous players? Or will the market weed out companies that use unsavory tactics to gain advantage? Perhaps Goldman Sachs and Comcast will lose clients as their ways are better known. Would it be to the advantage of the industry members to be regulated and to be trusted? Comcast failed to reveal that it was monitoring people's internet activities. Goldman Sachs' clients lost $1 billion. The rating agencies are widely regarded as a joke. Does the harm and trust that is lost to these industries detrimental to the industry as a whole? And finally, is it in the Common Good for the government to step in? Having hedge funds and Goldman Sachs benefit at the expense of widows and orphans (essentially pension funds) detrimental to society? Does restricting internet access put America and Americans at a disadvantage by restricting free markets and free flow of information? Or will free market forces ultimately pave the way to a fairer and better system? Food for thought.