"Next time, we'll get the regulations right"

Please take my advice: don't hold your breath.

James Surowiecki starts well.

M.M.S.’s bad behavior was unusually egregious, but it’s hard to think of a recent disaster in the business world that wasn’t abetted by inept regulation. Mining regulators allowed operators like Massey Energy to flout safety rules. Financial regulators let A.I.G. write more than half a trillion dollars of credit-default protection without making a noise. The S.E.C. failed to spot the frauds at Enron and WorldCom, gave Bernie Madoff a clean bill of health, and decided to let Wall Street investment banks take on obscene amounts of leverage, while other regulators ignored myriad signs of fraud and recklessness in the subprime-mortgage market.

As Samuel L. Jackson might shout, "Correct-a-mundo!" So what do we conclude? Surowiecki, alas, just doesn't get it:

These failures weren’t accidents. They were the all too predictable result of the deregulationary fervor that has gripped Washington in recent years, pushing the message that most regulation is unnecessary at best and downright harmful at worst. The result is that agencies have often been led by people skeptical of their own duties. This gave us the worst of both worlds: too little supervision encouraged corporate recklessness, while the existence of these agencies encouraged public complacency. . . . Too many regulators, for instance, are political appointees, instead of civil servants. This erodes the kind of institutional identity that helps create esprit de corps, and often leads to politics trumping policy.

Sorry, Mr. Surowiecki, but the regulators' errors are "predictable" but much more profoundly then you seem to recognize. I was going to compose a reply, but the Wall Street Journal's editorial yesterday does a fine job:

The liberals' fury at the President is almost as astounding as their outrage over the discovery that oil companies and their regulators might have grown too cozy. In economic literature, this behavior is known as "regulatory capture," and the current political irony is that this is a long-time conservative critique of the regulatory state.

The Nobel economist George Stigler of the University of Chicago was one of the concept's main developers, and it is a seminal plank of the "public choice" school of economics for which James Buchanan won the economics Nobel in 1986. Ronald Reagan warned about this in different words in one of his farewell speeches.

In the better economic textbooks, regulatory capture is described as a "government failure," as opposed to a market failure. It refers to the fact that individuals or companies with the highest interest or stake in a policy outcome will be able to focus their energies on politicians and bureaucracies to get the outcome they prefer.

Perhaps if liberals read more conservative economists, they might understand that this is a common consequence of the regulatory state that they have so diligently constructed over the decades. It is also a main reason that many of us are skeptical of the regulatory solutions routinely offered in response to every accident or business failure.

Or, as John Cochrane of the Univ. of Chicago--via Mark Perry--put it:

The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse.

Remember, the SEC couldn’t even find Bernie Madoff when he was handed to them on a silver platter. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent "In Fed We Trust" makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming.

Comments

[Luis Enrique]

so, do you believe that without regulation, Massey Energy would have spent more on safety, A.I.G. written less credit-default protection, Enron and WorldCom and Bernie Madoff would have been honest (or caught sooner?) and investment banks would have been less leveraged?

I find it easy to follow the "regulation will always be unsatisfactory" arguments, less easy to follow the "less regulation will lead to better outcomes" arguments, nor why those who are concerned about the effectiveness of regulation aren't interested in trying to strengthen it, rather than purposely neglect and undermine regulators, and then say "see how useless they are!"

[JorgXMcKie]

Is there some sort of prize for egregious point missing?

No one supportive of free markets that I am aware of claims they're perfect, or perfectible. The regulator loving types, though [see above], obviously believe, against all of human experience, that regulatory schemes *are* perfectible, evidently by being big enough.

Nonsense on stilts.

"Strengthening" regulations merely leads to greater corruption as the stakes grow higher.

And some "de-regulation" does work. See, e.g. the FCC and the phone company or the deregulation of airlines, etc.

For free marketers, the point is relatively available choices and acceptable outcomes for those in the market. For regulators [again, see above] the goal appears to be control [and no care at all about those being regulated or their customers].

[kyle8]

What is needed Luis is more independence and more auditing by regulators of the regulating agencies. (Who watches the watchmen ?)

For instance, the overuse of the Anderson accounting group by the government led indirectly to Worldcom and other disasters.

Politicians meddling were the single biggest factor in the Real estate bubble.

Screaming for MORE regulation when the existing regulation was not enforced is just stupid. What good will that do? It is like more hair of the dog that bit you.

Furthermore, no amount of regulation will help in every case. For instance, offshore drilling is one of the most heavily regulated industrial jobs that can be done, but it is inherently dangerous. Accidents might happen no matter what the regulations or how diligent the regulators are.

[Luis Enrique]

why, you seem like a charming individual.

I cannot see where you got the idea that I think that "regulatory schemes *are* perfectible", I think no such thing. I merely think that some regulators can be better than others, and attempts to improve regulation do not necessarily fail to do so (so I do not believe that 'strengthening' always leads to more corruption - where is the evidence please). And equivalently, I think it is possible to neglect and undermine regulators, in make them worse in doing so. These seem to be moderate and innocuous beliefs (if possibly false), not "regulator loving" at all. I am quite sure that "some deregulation" does work. For me, it's a case-by-case thing. I think it's a reasonable hypothesis that the generalized pro-market anti-government sentiment that prevailed until recently weakened regulation in some places we'd have liked to be be stronger, and I expect generalized anti-market pro-government sentiment may introduce regulations that do more harm than good.

I just don't see how I am missing the point to ask whether, in view of the myriad failures of regulation, our host thinks that all these bad things that transpired under regulation would have somehow been avoided with less regulation. Whether less regulation would make us better off with regard to the frequency and severity of bad things. It's not obvious to me that the observation that regulation has been ineffective (and has tendencies to always be always be ineffective to some extent) necessarily leads to that conclusion.

I cannot make head nor tail of your last para.

[Dave]

Luis -- thank you for making Craig Newmark's point for him. You believe regulations can fix everything. Yet you fail to see that all of the horrible things Craig cites happened when regulators then thought they were doing a good job. Regulatory capture is just one reason why government control/regulation does not fix market problems and make things great -- it may fix one problem but create another entirely. You hold to the belief that if we just get the regulations right, all will be great. We keep electing politicians that claim they can and will do just that, yet they somehow never seem to be able to. Perhaps you should stop looking for salvation in regulation; if it existed, we would have had it by now.

[Luis Enrique]

Dave,

I find it hard to believe you wrote that actually having read what I've written. Needless to say, you depiction of my views bears little relation to my actual views. It's not really worth responding to people who don't read what you write, is it?

[david foster]

Part of the problem is that too many regulators, at least at the top level, are *lawyers*, rather than people who actually understand the activity being regulated in any depth. This was the case with the woman who was running MMS. If the agency had been run by someone with experience in the *operational* side of mining/drilling, might things have been difference?

[Mike]

I think Milton Friedman addressed this when he talked about making a cat a dog (or was it the opposite).

The regulators are like cats. The cats are doing a great job regulating the financial industry except for the most recent crisis. We could have avoided the most recent crisis if we change the characteristics of the regulators so they can now bark, fetch, heel, ... That is, if only we can change the cats into dogs ...

The moral of the story is that those who are arguing for more regulations are asking for the impossible ...

[foxmarks]

The frame of “less regulation” begs the question, Luis.

You consider only those controls mandated by government as legitimate “regulation”. The agents in a market are their own regulators. Not self-regulating, but through competition and operation of the common law.

Regulatory capture depends on statute law. Eliminating some oversights that can be bought by campaign contributions and kickbacks reduces the opportunity for regulatory capture. Putting more oversight into the openly adversarial common law mechanism is not “less regulation”, merely different regulation.

[alanstorm]

Luis, you're missing the point. What we're hearing from the left now (well, to be honest, it's a perpetual whine) is that deregulation, even where they can't actually point to any, is the cause for the financial market collapse, the oil spill and pretty much everything else, and that we need, newer, better regulation of everything in sight in order to correct it.

What has happened time after time, as noted in the original post, is that the regulators aren't doing their jobs. Given this, and given that there is no reason to disbelieve that most if not all regulatory agencies act in the exact same way, why should anyone believe that a newer and better layer of regulation will cure anything?

Further, regulatory compliance is a cost on business which ultimately devolves to the consumer. Why exactly are we paying for this "protection", when it so manifestly fails repeatedly and hard? Why should we want even more?

I will grant that there is justification for regulation in many cases. However, it should be minimally intrusive, actually serve the public good, and be competently conducted. So far, government fails in all three regards.

[JorgXMcKie]

Luis, only someone who believes that regulatory schemes are perfectible would advocate correcting regulatory mistakes by more regulation. That's akin to saying that what a man bleeding to death needs is a couple of more stab wounds.

Let me ask this: if regulation isn't perfectible, then where, in your opinion, should it stop, and how would we know?

Or is it just "turtles all the way to the bottom"?