Regulators Can't Regulate – But the Market Can
By Veronique de Rugy
Many people simply take it for granted that government regulation achieves its intended ends. National political debates often reflect this: Doe-eyed Democrats position themselves as the forthright champions of the little guy, selflessly tying unscrupulous businessmen to the mighty yoke of the regulatory state. On the other side, smooth, corporate Republicans appeal to our inner entrepreneurs, decrying the lost productivity and forgone trickled-down growth that would torture our nation’s shackled conglomerates under the proposed new round of regulations.
Whether you’re pro-regulation or anti-regulation in America depends more on affiliation than reality. For better or worse, the truth is more insidious; regulators are often captured by the industry they regulate at the expense of everyone else.
Consider the recent revelation that the regulators at the Federal Reserve in New York were cozying up with one of the nation’s biggest financial institutions it was supposed to oversee. Secret recordings made by Carmen Segarra, a bank examiner for the Fed in New York—parked at Goldman Sachs—exposes the degree to which Fed regulators were actually failing the taxpayers they allegedly protect against the “too big to fail” corporations that the government created. For instance, in the recording, one can hear Fed officials explain how they suspect a Goldman deal with Banco Santander to be “legal but shady”—and then fail to challenge the firm. One can even hear both the regulators and Goldman executives acknowledge that the deal should have required Fed approval.
But then the regulators cave to the firm’s opinion that it is above the rules. This is not a unique event, Segarra reports. In fact, according to her, it was common belief among Goldman employees that, depending on the client, they could choose which consumer rules to follow—or not follow—without any fear of consequences from the Fed.
No matter how infuriating this is, it is neither a unique case nor a new phenomenon. In fact, for over 40 years we have known that the romanticized “protection of the public” theory of regulation doesn’t hold water. And yet, it is still so prominent today.
In his seminal 1971 article, “The Theory of Economic Regulation,” (PDF) Chicago School economist George Stigler let America in on Washington’s dirty little secret: Regulations can be a capitalist’s best friend. He pointed out that industries with sufficient resources and political power have a huge incentive to exploit the state’s coercive power for their own ends. What might look like a regulation for the public interest from the outside is often little more than “regulatory capture” by corporate interests...