Todd Suomela's Library tagged regulatory-capture →  View Popular

It is unlikely that consumers will ever hold much influence over the realities of the financial regulatory process because they are not organized in comparison to the financial industry, which concentrates significant resources in the creation of inefficient regulators. By and large, consumers are not well-informed about what they have at stake in the regulatory process and, even if they were, that would not be the sole determinant of how they define themselves politically.

Adding another layer of guards to guard the existing guards ultimately results in an infinite regress. I do not think it is cynical to suggest that, absent an actual paradigm shift with respect to accountability in the financial industry, we are just going to have more of the rent-seeking that has gone on to date and the economic calamities that ensue. For my part, I would propose opening up financial regulation to a small group of social entrepreneurs. Let people establish for-profit companies that can compete for government contracts to stress test the holdings of financial institutions independently and audit their records.

Specifically,  Lawrence H. Summers and  Timothy F. Geithner are arguing against putting large banks through the bankruptcy and restructuring procedures advocated by some senior Federal Reserve officials (see the  Congressional testimony of Thomas Hoenig on Tuesday). If major banks fall in this way, the Treasury Department and the White House point out, this will cause irreversible damage — after all, once a bank has been restructured, it can never be the same again.

As a result, Mr. Summers and Mr. Geithner prefer forbearance for banks — i.e., look the other way on big banks’ problems and hope an economic recovery brings them back to sustained profits (on this, the latest news is not so positive). And to encourage a recovery, the White House is seriously contemplating further huge fiscal stimulus. If that doesn’t work, Mr. Summers and Mr. Geithner reason, they can always take big financial institutions through bankruptcy later.

An alternative strategy would be:









1. Minimize risks of failure by resolving problems in a transparent manner — which is a nice summary of President Obama’s strategy in spheres other than banking — and by reducing debilitating uncertainty.
2. Incur some immediate costs to set the country on a sound footing for the near future. If it is at all politically possible to take decisive action, do so. This is known in the administration as Rahm’s Doctrine, but it is not being applied to banks.
3. Don’t push more costs onto future generations. The United States is going to be competing with low-debt, low-tax nations for the next century. To protect our national interests this country cannot afford to be too indebted.

The parallels to the modern-day United States, though not exact, are plain enough. This country’s long period of economic pre-eminence has produced a set of interest groups that, in Olson’s words, “reduce efficiency and aggregate income.” Home builders and real estate agents pushed for housing subsidies, which made many of them rich but made the real estate bubble possible. Doctors, drug makers and other medical companies persuaded the federal government to pay for expensive treatments that have scant evidence of being effective. Those treatments are the primary reason this country spends so much more than any other on medicine. In these cases, and in others, interest groups successfully lobbied for actions that benefited them and hurt the larger economy.

Surely no interest group fits Olson’s thesis as well as Wall Street. It used an enormous amount of leverage — debt — to grow to unprecedented size.