Here’s more on the subject of how state interference in the economy kills innovation.

From the Wall Street Journal:

Here’s a stumper: In the Treasury financial reform proposal, who comes in for more regulatory retooling: Fannie Mae, or your average 14-man venture capital shop? If you said venture capital, you understand why one of America’s greatest competitive advantages is now at risk in Washington.

 As part of their regulatory redesign, Team Obama and Congress still don’t have a plan for reforming the giant taxpayer-backed institutions like Fannie that caused the credit crisis. Yet they’re moving to rewrite the rules for investing in tiny technology companies that had nothing to do with the meltdown. Under the proposed rules, venture firms will be declared systemic risks until they can prove themselves innocent. The typical venture capital (VC) firm has nine principals plus five support staff and doesn’t use leverage. Yet Treasury Secretary Timothy Geithner wants VCs to be regulated as investment advisers by the Securities and Exchange Commission…

Venture firms were invented in the 1960s to fund the California semiconductor companies that would change the world but needed investors willing and able to take a flying leap into the unknown. Under the Silicon Valley model that has since spread around the country, experienced technology executives at VC firms inject advice and cash into young businesses.

 Neither too big nor too interconnected to get a taxpayer bailout, VCs are nonetheless critical to America’s ability to stage an economic rebound. While early-stage venture investments are tiny by Wall Street standards—often $3 million or less—they are a big part of the reason the United States has for decades grown faster than other industrialized economies. Companies once backed with venture capital now generate more than 20% of U.S. gross domestic product. Looking forward, will America be better off if venture investors are justifying themselves to Washington regulators, or evaluating new software platforms?…

Treasury’s position is that if it doesn’t drag VC firms into the bureaucratic swamp, then high-rolling hedge funds playing with borrowed money will present themselves as venture funds to avoid regulation. Yet any firm calling itself a VC is already subject to the antifraud provisions of federal securities laws. VCs also have to describe the funds they raise in annual Form D filings with the SEC. Washington could let the SEC address any concerns simply by adding three questions to the form: Do you use leverage? Do you trade equities or debt? Do you trade derivatives? Anyone answering “no” to all three would be free to go find the next Microsoft.

 The reality is that the venture industry is already shrinking, for market and political reasons. Too many funds chasing too few ideas after the dot-com boom have limited returns. And thanks in part to earlier VC investments, cheap tech tools are allowing some Web entrepreneurs to bootstrap their businesses without having to sell pieces to VCs.

As for the politics, Sarbanes-Oxley compliance costs, Eliot Spitzer’s stock-analyst settlement and the economic downturn have created an historic drought in venture-backed companies going public. This week Dow Jones VentureWire warned readers not to expect more such companies going public “anytime soon.” It boggles the mind that Washington would enact new policies sure to prolong this drought and strike at the heart of American innovation.