It’s not the regulators, it’s the politicians

By Felix Salmon
August 29, 2009
Aditya Chakrabortty has a UK perspective on financial reform:

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Aditya Chakrabortty has a UK perspective on financial reform:

The first chapter of Alistair Darling’s July white paper on banking reform was devoted to explaining just how important the City is to the UK economy. The Treasury’s ledger of revenues from financial services did not include a debit column that listed the amount lost on institutional bailouts and tax avoidance – of course it didn’t. Put to one side, if you can, the watchdogs’ manifold failings in the run-up to the banking crisis. In the debate over reforming the City there has been none of the regulatory capture that economists usually fret about – where the regulators forget about the public interest, and rig the rules to suit the very sector they’re meant to be supervising. There is, however, plenty of evidence of political capture. This isn’t just a New Labour problem; it applies also to David Cameron and George Osborne, whose policies are nowhere near as tough as their rhetoric – and to Barack Obama’s administration, which, on everything from regulating bonuses to handing out taxpayer money, appears to have turned into an unglamorous subsidiary of Goldman Sachs. A cast like this means the prospects for real reform at next month’s G20 summit of major economies in Pittsburgh are depressingly slim.

I think that making the distinction, as Aditya does here, between “manifold failings” and “regulatory capture” is a very useful thing to do. A regulator who failed is not necessarily a captured regulator.

Aditya’s also right that the real problem here is that regulators are appointed by politicians, and it’s the politicians who are captured. The banks don’t need to capture their own regulators: all they need to do is capture the politicians who appoint them. If you’ve got Phil Gramm deciding who gets appointed, you’ve won your battle before it’s even fought.

This is one more reason why consolidating regulatory power in the central bank is a good idea: even if the central bank isn’t totally independent, it’s more independent than any other regulatory agency is ever going to be, and therefore less likely to become filled with political hacks. Say what you like about the Fed, you’re not going to see it demonstrate the kind of premeditated spinelessness that the SEC commissioners showed over most of the past 10 years. If we want effective regulation, we’re going to have to remove power from politicians, many if not most of whom receive enormous campaign donations from precisely the companies they would regulate.

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Comments
9 comments so far

Sorry, Felix, I have to disagree on a central point. You say: “(The central bank)’s more independent than any other regulatory agency is ever going to be, and therefore less likely to become filled with political hacks.”

Well, while it may nominally be more “independent” from political influence than a regulatory agency, that’s not the point. The point is that it is owned–literally and figuratively–by the finance industry and, in the end, is far more likely to pursue their interests than the public’s (as it has in this financial crisis). In contrast, to “own” a regulatory agency, the finance industry must first “buy” some politicians (large contributions, lots of fawning a-kissing) who then appoint their various lackies–a more complex two-step process.

In short, there is nothing inherently superior about the behavior of a financial regulator just because it’s not overseen by politicians. Indeed, I would say the wholly-owned Fed is a strong argument for a consumer protection agency that has authority and resources to cover the board.

Posted by Lilguy | Report as abusive

I’m guess I’m mostly with Felix on this one. Any government body can be captured by special interests, but the Fed seems to have more independence than other bodies.

Although perhaps members of the Board of Governors should get lifetime appointments, instead of just 14 years. IMO, that would foster even more independence.

Politics may drive initial appointments, but over time, and with enough job security, independence often does emerge and prevail.

Felix, wow. I think you’re engaged in a little magical thinking.

Lilguy hits the nail on the head.

The Fed has a responsibility to police its own membership and impose safety and soundness rules only on its member banks. It also has a global role, through the BIS, in developing and improving coordinated safety and soundness standards for all central banks.

It’s independence is also designed to provide a check on the govts natural inclination to debase the currency.

These critical missions aren’t compatible with overseeing the entire financial marketplace. Their institutional bias for minimal disclosure, as the Bloomberg FOIA battle shows, should give us pause if we are to consider them for the uberregulator role in the US. The disclosure concerns of a central banker are in conflict with the need for impoved transparency that should underpin any of the non Fed regulatory changes going forward.

Why would we want to house those conflicts in an institution ‘independent’ of political pressure, when that instituion’s DNA demands less disclosure and minimal external interference over more.

The Fed seems like a superficially seductive choice when its compared to the ineptitude of the SEC and some of the other banking regulators, and the regulatory and leglisative capture that currently exists. But there must be better ways to combat regulatory capture than by locking that capture in an institution removed from direct political pressure. We need to run from the “Trust me, I know whats best” crowd, not get into bed with them.

I’d rather we face up to the fact that money talks and fund a public advocates office headed by Eliz Warren, whose budget would be matched $ for $ private lobbyists. Let the lobbyists and her anti lobbyists battle it out with legislators. It might make the legislators more accountable and they might favor their constituents if they were paying as well as the lobbyists.

The Fed’s independence is anti democratic, but we live with the dissonance. As long as the world has fiat currencies, their independence is tolerable.

But the institution should be an anomoly, not a model for a broad based finacial markets regulator, and cetainly not its home.

Not to mention, the Fed’s competance is still an open question. Their role in the current mess still needs more study before they are considered for additional responsibilities. Greenspan’s mea culpa still appalls, and its not clear yet if Bernanke has repudiated Greenspan’s most damaging ideas.

How anyone who lives in the fourth estate can support increasing power to an instituion removed from political influence is beyond me.

Posted by michael | Report as abusive

I think this post suffers as an example of one of the pitfalls of blogging: on its surface there is a logic that further examination would dispel (unless one wishes to complete the plutocratic takeover of the US economy). I think Lilguy and michael nail it.

Posted by Yankee Frank | Report as abusive

While I have sympathy with the point that “If we want effective regulation, we’re going to have to remove power from politicians, many if not most of whom receive enormous campaign donations from precisely the companies they would regulate”, the following is utterly baffling:

“Say what you like about the Fed, you’re not going to see it demonstrate the kind of premeditated spinelessness that the SEC commissioners showed over most of the past 10 years.”

Seriously? The Fed under Greenspan did not demonstrate “spinelesness” when it comes to regulating the financial institutions under its charge? Surely one can argue what the cause of the spinelesness was, but that the Fed was spineless seems beyond debate.

Posted by Carlomagno | Report as abusive

And another thing (Sorry Feilix the pickings are too rich in your article to resist)

“one other thing it’s more independent than any other regulatory agency is ever going to be, and therefore less likely to become filled with political hacks”

Is the Fed more independent of political control than FINRA? Hardly. Are you suggesting that the FINRA model of self serving self regulation is the ideal we should aspire to?

Although there is so much populist rage (rightly) directed at the SEC at the moment, most coverage ignores the fact that the securities markets are self regulated by FINRA on behalf of the SEC. Its a shame that detail is lost amid the noise.

In the proposals for Fed as superregulator, FINRA would remain independent run, reporting to another independent instituiton.

I think there may be a problem with sheltering the regulator for the banks and the securities industry from the tedious interference of the politicians. The odious politicians have a role in protecting the citizens from such a concentration of power. Your conclusions assume that politicians, and by extension, gov’t will continue to fail us. That may be so, but stacking the deck against them (and us) seems like the worst path to take, not the best.

Posted by michael | Report as abusive

“premeditated spinelessness” – I don’t think I could have come up with a better phrase for the SEC. I’ve occassionally wondered if their negotiations with an offender begin with an offer of “no admission of wrongdoing”, a fine of $12 (adjusted for inflation since the mid-70′s) and having the alleged offender fill out a satisfaction survey.

Posted by PM | Report as abusive

How can you say the Fed is more independent than the FDIC? It’s not even more independent than the OCC. The Fed and the OTS/FSLIC have been in a constant race to see who could be the most lax agency over the last 20 years. The best solution is to build a culture of regulation which both the OTS and the Fed lack, or completely insulate regulation from monetary policy.

Posted by renholder | Report as abusive

I have liked the ‘outsourcing regulatorship’ idea the best so far
http://baselinescenario.com/2009/08/08/f illing-the-financial-regulatory-void/

Posted by Marian | Report as abusive
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