By Simon Johnson, co-author of White House Burning: The Founding Fathers, Our National Debt, And Why It Matters To You

From the 1970s until recently, Congress allowed and encouraged a great deal of financial market deregulation – allowing big banks to become larger, to expand their scope, and to take on more risks. This legislative agenda was largely bipartisan, up to and including the effective repeal of the Glass-Steagall Act at the end of the 1990s. After due legislative consideration, the way was cleared for megabanks to combine commercial and investment banking on a complex global scale. The scene was set for the 2008 financial crisis – and the awful recession from which we are only now beginning to emerge.

With the so-called JOBS bill, on which the Senate is due to vote Tuesday, Congress is about to make the same kind of mistake again – this time abandoning much of the 1930s-era securities legislation that both served investors well and helped make the US one of the best places in the world to raise capital. We find ourselves again on a bipartisan route to disaster.

The Senate needs to slow down and do its job – we have two legislative bodies for a reason and the Senate’s historical role is partly to serve as a check on enthusiasms that may suddenly sweep the House. To pass this legislation on Tuesday would be a grave mistake.

The idea behind the JOBS bill is that our existing securities laws – requiring a great deal of disclosure – are significantly holding back the economy.

The bill, HR3606, received bipartisan support in the House (only 23 Democrats voted against). The bill’s title is JumpStart Our Business Startup Act, a clever slogan – but also a complete misrepresentation.

The premise is that the economy and startups are being held back by regulation, a favorite theme of House Republicans for the past 3 ½ years – ignoring completely the banking crisis that caused the recession. Which regulations are supposedly to blame?

The bill’s proponents point out that Initial Public Offerings (IPOs) of stock are way down. That is true – but that is also exactly what you should expect when the economy teeters on the brink of an economic depression and then struggles to recover because households’ still have a great deal of debt. And the longer term trends over the past decade are global – and much more about the declining profitability of small business, rather than the specifics of regulation in the US (see this testimony by Jay Ritter).

Professor Ritter, a leading expert on IPOs, put it this way:

“I do not think that the bills being considered will result in a flood of companies going public. I do not think that these bills will result in noticeably higher economic growth and job creation.”

In fact, he also argued that the measures under consideration “might be to reduce capital formation.”

Professor John Coates hit the nail on the head:

“While the various proposals being considered have been characterized as promoting jobs and economic growth by reducing regulatory burdens and costs, it is better to understand them as changing, in similar ways, the balance that existing securities laws and regulations have struck between the transaction costs of raising capital, on the one hand, and the combined costs of fraud risk and asymmetric and unverifiable information, on the other hand.” (See p.3 of this December 2011 testimony.)

In other words, you will be ripped off more. Knowing this, any smart investor will want to be better compensated for investing in a particular firm – this raises, not lowers, the cost of capital. The effect on job creation is likely to be negative, not positive.

Sensible securities laws protect everyone – including entrepreneurs who can raise capital more cheaply. The only people who lose out are those who prefer to run scams of various kinds.

Investor protection is good for growth and essential for sustaining capital markets. Experiments involving doing without such protections – as in the Czech Republic in the early 1990s, for example, have not gone well. There might be a temporary frenzy, but the subsequent fall to earth will be painful – and again hard to recover from.

Perhaps the worst parts of the bill are those provisions that would allow “crowd-financing” exempt from the usual Securities and Exchange Commission disclosure requirements. A new venture could raise up to $1-2 million through internet solicitations, as long as no investor puts in more than $10,000 (section 301 of HR3606). The level of disclosure would be minimal and there would be no real penalties for outright lying. There would also be no effective oversight of such stock promotion – returning us precisely to the situation that prevailed in the 1920s.

This might well pump up the value of particular stocks – that was the experience of the 1920s, after all. But ephemeral stock market bubbles are not without real consequences. The crash of 1929 was made possible by the lack of constraints on what stock promoters could say and do. Combined with excessive leverage, this led directly to the Great Depression.

We still have excessive leverage in our financial system today, despite the claims of the Federal Reserve. Allowing the unrestricted promotion of stocks in this fashion is a major step – again – down the path to economic self-destruction.

The legislation would also undo many parts of the 2002 Sarbanes-Oxley law, which was created in the wake of accounting scandals at the likes of Enron and WorldCom. The proposed new rules have been crafted hastily and pushed through in a great rush – presumably because the election season is upon us.

Where are the supposed guardians of our financial system?

The White House is reportedly taken with the idea of crowd-financing and wants a quick political win in the form of legislation; the Obama administration is poised to concede too much to financial sector interests, again. The Treasury Department likes to claim it provides “adult supervision” for all matters financial, yet it is conspicuously absent from serious conversation around this legislation. And he much-vaunted Financial Stability Oversight Council turns out, again, to be a meaningless paper tiger.

The securities industry special interests are naturally out in force – strongly supported by Senator Charles Schumer of New York and Majority Leader Harry Reid. Reports of the death of Wall Street lobbying power have been greatly exaggerated.

Financial deregulation was the result of decades-long delusion and bipartisan consensus. A major undermining of our securities law seems likely to take place on Tuesday – in a rushed moment of legislative madness.