Every loan bears some risk that it will not be repaid. In making a loan, a prudent lender will accurately price the risk of the loan. Regulations that interfere with the ability to price risk accurately leads lenders to reduce their risk exposure by curtailing lending.

Since President Obama’s comprehensive financial overhaul bill would fundamentally reshape the banking system, how can borrowers and lenders possibly price their risks? How can lenders make a loan today knowing that a new Bureau of Consumer Financial Protection or state attorney general might later decide the loan is “abusive?” Or what future taxes will have to be levied to fund our unsustainable budget deficits?

They can’t.

Washington’s tax-and-regulation orgy spawns unworkable uncertainty for small businesses and banks, leading to curtailed lending. But the inability to accurately price risk goes beyond macroeconomic-level uncertainty: Congress’ meddling in credit markets has directly interfered with the ability of lenders to price the risk of lending accurately. Proposals for still more interventions compound uncertainty, further undermining confidence and predictability.

Consider the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (the “Credit CARD Act”). While some of the provisions of the legislation are largely harmless or even mildly beneficial, other provisions of the law interfere with accurate risk-based pricing, such as limitations on the ability to raise interest rates or declare a default when borrower risk increases.

The market response has been entirely predictable - faced with new limits on the ability to raise interest rates when borrower risk changes, lenders have simply raised interest rates for all cardholders. Equally predictably, card issuers have reduced their risk exposure by slashing available credit lines by more than $1 trillion in the past year, canceled thousands of cards and levied new fees on inactive and other risky accounts. The obstacles created by the CARD Act encouraged this outcome.

About three-quarters of small businesses rely on credit cards (often their personal cards) to finance their businesses, especially women and minority entrepreneurs, who frequently are excluded from traditional small-business lending. This legislative assault on access to credit cards has slowed economic recovery and driven consumers and small businesses into the hands of pawnbrokers and payday lenders.

But this pummeling of the credit card market is still not enough for Congress and the Obama administration. A House bill introduced by Rep. John F. Tierney, Massachusetts Democrat, (with more than 60 co-sponsors) would impose a national interest rate ceiling of 16 percent on credit cards. This guarantees a massive constriction of credit card availability with an accompanying boom for payday lenders and car title loan companies. (These are widely misunderstood and underappreciated institutions but that is another column.)

The looming creation of a new Bureau of Consumer Financial Protection in the Federal Reserve with the authority to regulate virtually every consumer credit product in America and to punish those loans deemed (after the fact) to be “abusive” will further discourage lending to consumers and small businesses. Congress also is still considering allowing bankruptcy judges to “cram down” underwater mortgages and home equity lines of credit to the value of the underlying home. This would further increase their risk and probably be a death knell for home equity lines of credit, a major source of small-business capital.

Bureaucrats also are to blame. Although Treasury secretaries have promoted lending to spur economic recovery, the incentives of individual bank examiners counter this goal. Bankers complain that bank examiners claim they want banks to increase lending, but have become obsessively cautious in how they value a bank’s assets, especially real estate. This produces shrinkage in lending.

Bureaucrats face well-known incentive problems that lead them to be more risk averse than is socially optimal. For example, analysts have long observed that the Food and Drug Administration can claim little credit for speeding a beneficial drug to market quickly, but gets massive political criticism if it fails to block a dangerous drug.

Similarly, individual bank examiners can claim little credit if responsive oversight enables a particular bank to increase its lending slightly, thereby promoting economic recovery. But any given bank examiner will be penalized if “his” bank fails. As a result, bank examiners error on the side of caution, even if that defeats the administration’s goals of expanding lending. The narrow-gauge mission of the new Bureau of Consumer Protection virtually guarantees that its head will face similar pathological incentives to act overcautiously, thereby stifling innovation and exacerbating the credit crunch.

Legend holds that the term laissez-faire originated when Louis XIV's finance minister, Jean-Baptiste Colbert, asked French industrialists what the government could do to assist their business. Laissez-faire – “leave us alone” - was the response. Banks and businesses all over America are saying the same thing today - if only Washington will listen.