Getting Beyond Regulation

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The theory on how to best protect the public from private sector wrongdoing consists basically of regulation. From the Federal Reserve Act nearly a century ago to the Securities and Exchange Commission (SEC) during the Depression to the Environmental Protection Agency (EPA) in 1970, we have largely trusted that a federal authority could effectively monitor, and if necessary punish, businesses.

Regulation’s limitations became too obvious to deny during the Bush years. The EPA, not exactly a pit bull to begin with, became almost totally, laughably ineffective (via). To be fair, environmental protection has been derided by conservatives as business unfriendly, myopic, job killing do-gooderism run amok for decades. It is not surprising that the agency had trouble getting the widespread support needed to sustain real vigilance. Also, compared to some of its sister agencies the EPA was a paragon of rectitude.

Even under the best circumstances regulation is destined to be under perpetual assault from those who would benefit from its absence. If you look, for instance, at the way Goldman Sachs Group Inc. (which incidentally is an anagram for "a cad churning smog slop") installed a revolving door between its boardroom and Washington, it becomes unsurprising that regulation of it has ceased (here is this week’s scandal).

The neutering of regulatory bodies may paradoxically cause those in them to have a positively exalted view of themselves. For example, here is Simon Johnson’s mild take on Goldman’s latest: "If the Federal Reserve were an effective supervisor, it would have the political will sufficient to determine that Goldman Sachs has not been acting in accordance with its banking license. But any meaningful action from this direction seems unlikely." Contrast that with Minneapolis Fed President Narayana R. Kocherlakota’s almost messianic view of the Fed:

My theme here is that this improvement in our economic situation is attributable in large part to actions taken by the Federal Reserve. I will emphasize that the Federal Reserve was only able to undertake these actions because of the expertise and information it had acquired as a supervisor of the nation’s banks. My conclusion is that stripping the Federal Reserve of its supervisory role would needlessly put a Great Depression on the menu of possibilities for our country.

(He appears, by the way, to be another inflation crusader. Look at the last two paragraphs of page six for a truly bizarre scenario on the dangers of inflation. I particularly like the line "Suppose that households believe prices will rise.")

In short, regulation has a spotty track record lately. Economist Barry Ritholtz acknowledged that and pointed to a new approach when he wrote a recent proposal "would not have prevented this crisis, but it would reduce taxpayer exposure to Wall Street speculation." Since regulation depends on human intervention, it would be good to have a simple mechanism that reduced the public’s exposure to abuse.

Think about the surprisingly durable support for a public health insurance option. It bypasses regulation completely. It says to the industry: do what you want, charge what you want, chart your own course – we will not interfere; we’ll just be over here with our own operation that folks can pick if they want. Those who wish to reduce their exposure to the wonders of laissez faire capitalism can sign up. The rest can go with you. What rugged individualist could possibly object? (The main objection to it – that it would undercut the private sector and drive it out of business – raises the obvious question: then what value is the industry providing?)

Similarly, Brent Budowsky recently called for a "public option bank" that would offer a small menu of simple, ordinary services for those who prefer not to take their chances with Citibank or Bank of America. It would not impact the private sector in the slightest – no new taxes, regulations or hoops to jump through. It would just provide an alternative to those who wanted reduced exposure. Those with a taste for swashbuckling capitalism can throw in with Wall Street, those who prefer less excitement can have it.

The "quarantined risk" model will not work for everything. You cannot very well have a government protected patch of the environment and let industry turn the rest into a Superfund site, for example. It does mark the emergence of a new possibility, though, and one that would be an excellent hedge against failed regulation. If it keeps getting traction look for even its most innocuous expressions to be ferociously opposed, because it will represent not just a change in policy or political alignment, but a change in the way we think.

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