Obama and “Regulatory Capture”

Thomas Frank says the administration’s regulatory overhaul plan is not putting enough emphasis on the problem of regulatory capture:

Obama and ‘Regulatory Capture’, by Thomas Frank, Commentary, WSJ: …We have just come through the most wrenching financial disaster in decades, brought about in no small part by either the absence of federal regulation or the amazing indifference of the regulators.

This is the moment for a ringing reclamation of the regulatory project. President Barack Obama is clearly the sort of man who could do it. But … a white paper his administration released on the subject last week … uses bland, impersonal explanations for the current crisis. Regulatory agencies were ill-designed… Their jurisdictions overlapped. They had blind spots. They had been obsolete for years.

All of which is true enough. What the report leaves largely unaddressed, however, is the political problem. … The people who filled regulatory jobs in the past administration were asleep at the switch because they were supposed to be. …

The reason for that is simple: There are powerful institutions that don’t like being regulated. Regulation sometimes cuts into their profits… So they have used the political process to sabotage, redirect, defund, undo or hijack the regulatory state since the regulatory state was first invented.

The first federal regulatory agency, the Interstate Commerce Commission, was set up to regulate railroad freight rates in the 1880s. Soon thereafter, Richard Olney, a prominent railroad lawyer, came to Washington to serve as Grover Cleveland’s attorney general. Olney’s former boss asked him if he would help kill off the hated ICC. Olney’s reply … should be regarded as an urtext of the regulatory state:

“The Commission . . . is, or can be made, of great use to the railroads. It satisfies the popular clamor for a government supervision of the railroads, at the same time that that supervision is almost entirely nominal. Further, the older such a commission gets to be, the more inclined it will be found to take the business and railroad view of things. . . . The part of wisdom is not to destroy the Commission, but to utilize it.”

The George W. Bush administration elevated this strategy to a snickering, sarcastic art form. It gave us a Food and Drug Administration that sometimes looked as though it was taking orders from Big Pharma, an Environmental Protection Agency that could never rouse itself from the recliner, an energy policy that might well have been dictated by Enron, and a Consumer Product Safety Commission that moved like a rusty wind-up toy.

And it created a situation where banking regulators posed for pictures with banking lobbyists while putting a chainsaw to a pile of regulations. …

Misgovernment of this kind is not a partisan phenomenon, of course. Democrats have been guilty of it as well as Republicans. … Yet today we talk around this problem, with its nose-on-your-face obviousness, as though it didn’t exist. It’s not until page 29 of the Obama administration’s densely worded white paper that you find a reference to “regulatory capture,” and then it is buried in a list of items to be considered by a future Treasury working group. …

[T]he administration must go further. … After all, the Bush team was only able to install the dreadful regulators it did because the governance of federal agencies was rarely a topic of public debate in those days. Mr. Obama should make it an unavoidable subject, something that future politicians will be required to address. The issue cries out for it. And the nation, for once, is listening.

I see this a little bit different. I think the regulatory capture that helped to open the door for the current crisis had more to do with the adoption and promotion of free market ideology and the culture that ideology brought about within the regulatory bodies than to direct capture by regulated industries.

The financail industry certainly promoted the free market, self-healing, self-regulating approach since it coincided with their interests in shedding regulatory constraints, and they also aided politicians who promoted these ideas. Those politicians, in turn, made appointments to key positions within regulatory agencies that were designed to further this ideology and that, too, contributed to the changing culture within the regulatory bodies.

But the idea that, in almost all cases cases markets will self-correct and self-regulate, and that society is best served with a hands off approach to these markets, did not originate within industry. It came from a dominant strain of economic thought supported by theoretical models and empirical evidence. Without the support of these models, the empirical evidence, and the many economists who carried the message – and most of the profession did – it would have been much more difficult for industry to successfully promote the “deregulation is good for everybody always and everywhere” within the political and regulatory arenas.

I don’t want to be mistaken here, I still believe that most markets function well with minimal regulation, and that a hands off approach is generally best. But I hope we have learned that financial markets are not among the markets for which this is true. I also hope that, as a profession, we will be more receptive to the idea that markets can fail, and can do so catastrophically, that we will build models that help us to better understand how to minimize the risk that markets will break down, and more importantly that we will interpret data with this in mind. All of the data in the world is useless if you cannot see, refuse to see, or cannot accept what it is trying to tell you.

Originally published at Economist’s View and reproduced here with the author’s permission.

3 Responses to "Obama and “Regulatory Capture”"

  1. JoyceF   June 24, 2009 at 9:59 am

    “It came from a dominant strain of economic thought supported by theoretical models and empirical evidence…”To what empirical evidence are you referring?

  2. awakened   June 24, 2009 at 11:17 am

    “…most markets function well with minimal regulation, and that a hands off approach is generally best.”The only markets that will function well without regulation are the ones that the Merchants of Debt and their minions are not interested in controlling. And when regulated they will continue to control their interests through the political and regulatory processes, as the author has written.Schumpeter’s Law of Creative Destruction is dead when all the moneychangers have to do is buy out all the ideas, patents and technologies that threaten the control of their interests. And when they can’t do that, or when they find it more convenient, they will find another way to destroy their competition. They are plunderers at heart and have no desire to change and do what is right.Credit Default Swaps are illegal as insurance vehicles because there is no insurable interest required for the purchaser of them. This is Insurance Basics 101. Brooksley Born knew this and so did everyone else who had any power to do anything about the regulation of them including Greenspan, Rubin, Summers, and Giethner.Where is Justice? She cries out in the streets. Can you not hear her?

  3. Caveat Emptor   June 24, 2009 at 4:45 pm

    It’s amazing that there has been so little mention of Professor Minsky’s analyses and warnings going back 30 years that STABLE, WELL-FUNCTIONING, EFFICIENT, and SUCCESSFUL Capitalism ALWAYS and INHERENTLY produces destabilizing financial excess that – if unchecked by regulatory control processes – build to the point of catastrophic financial collapse. He (and Charles Kindleberger and many others) provided empirical examples, and Minsky (1986) went into great explanatory detail about the outcome of replacing face-to-face individual credit evaluation with high-volume un-evaluated generic credit systems; it reads like a perfect roadmap of the rise and fall of “structured finance.” The reason all of business, academia, and government chose the “unregulated markets can do no wrong” justification for enthusiastically de-regulating and un-regulating the financial craziness that built for the last three decades was NOT because there was clear empirical evidence of the superiority of such a model or lack of contrary models being presented, but because everyone loves a wild-west bubble expansion on the way up and contrary voices predicting a bad outcome are driven from the public square. The current Administration, Congress, and Federal Reserve (and all the rest of us) are deeply intwined with the financial system that ran amok and is currently on governmental life-support, and any regulatory changes (as contrasted with rhetoric) that threatens the “free market supremacy” model will continue to be labeled “socialist” and “communist” and eliminated, undone at a convenient future time, or ignored altogether.