Tag Archives: regulation

Tobin Project Book on Regulatory Capture

By James Kwak

One of the last things I did in law school was write a paper about the concept of “cultural capture,” which Simon and I discussed briefly in 13 Bankers as one of the elements of the “Wall Street takeover.” The basic idea was that you can observe the same outcomes that you get with traditional regulatory capture without there being any actual corruption. The hard part in writing the paper was distinguishing cultural capture from plain old ideology—regulators making decisions because of their views about the world.

Anyway, the result is being included in a collection of papers on regulatory capture organized by the Tobin Project. It will be published by Cambridge sometime this year, but for now you can download the various chapters here. It features a lineup including many authors far more distinguished than I, including Richard Posner, Luigi Zingales, Tino Cuéllar, Richard Revesz, David Moss, Dan Carpenter, Nolan McCarty, and others. Enjoy.

Americans Like Regulation

By James Kwak

It’s a well-known fact that Americans oppose government spending in the abstract yet favor virtually every government spending program. For example, last April Gallup reported that 73 percent of Americans blame the deficit on excessive spending and 48 percent wanted to reduce the deficit mainly through spending cuts (and 37 percent equally with spending cuts and tax increases). Only a few months before, however, Gallup also reported majorities opposed to cutting spending on anything—even “funding for the arts and sciences”—except foreign aid.* (This is not an isolated poll; see, for example, Washington Post-ABC News, April 2011, questions 14 and 17.)

Most government spending does go to popular programs like Social Security, Medicare, and Medicaid. I suspected, however, that most Americans would want to cut spending on federal regulatory agencies; I thought that they just overestimated the amount of spending on regulation, which is tiny compared to the large mandatory spending programs. (The Consumer Financial Protection Bureau, for example, last year put in a budget request of around $300 million—less than one-one-hundredth of a percent of total federal spending.)

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Not All Businessmen Are Smart, You Know

By James Kwak

Stephen Carter, a professor at the Yale Law School and an accomplished novelist, wrote a Bloomberg column based on a conversation with a medium-sized business owner he met on a plane. The gist of the column is that the businessman isn’t hiring more workers because he’s worried about the regulations changing on him. From this, Carter draws a general lesson about business and government:

“For medium-sized firms like his, however, there is little wiggle room to absorb the costs of regulatory change. Because he possesses neither lobbyists nor clout, he says, Washington doesn’t care whether he hires more workers or closes up shop. . . .

“Recessions have complex causes, but, as the man on the aisle reminded me, we do nothing to make things better when the companies on which we rely see Washington as adversary rather than partner.”

Jim Henley (hat tip Brad DeLong) has already pointed out the silliest thing about this column: anyone who has a growing business and isn’t hiring more people, and isn’t hiring them because he’s not sure about future regulatory changes, is making a mistake (or perhaps is in a very unusual business that is heavily exposed to some very particular and very concrete regulatory risk).

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The Problem with Biomass, Part 2

By James Kwak

I’ve already introduced you to the Springfield biomass plant proposed by Palmer Renewable Energy (PRE). The issue in that post was PRE’s witnesses’ apparent unfamiliarity with the voluminous evidence that ambient air pollution increases both the incidence and the severity of asthma, along with other diseases.

In addition, PRE is claiming that their biomass plant won’t increase air pollution, anyway. In this press release gracefully repackaged as a news story by the Springfield Republican, we read, “The average annual impact on emissions such as nitrogen dioxide, sulfur dioxide, and particulate matter would be minuscule, Valberg and Raczynski [PRE's environmental consultants] said.”

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Food and Finance

By James Kwak

I just read Michael Pollan’s book, In Defense of Food, and what struck me was the parallels between the evolution of food and the evolution of finance since the 1970s. This will only confirm my critics’ belief that I see the same thing everywhere, but bear with me for a minute.

Pollan’s account, grossly simplified, goes something like this. The dominant ideology of food in the United States is nutritionism: the idea that food should be thought of in terms of its component nutrients. Food science is devoted to identifying the nutrients in food that make us healthy or unhealthy, and encouraging us to consume more of the former and less of the latter. This is good for nutritional “science,” since you can write papers about omega-3 fatty acids, while it’s very hard to write papers about broccoli.

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The Tilted Playing Field

By James Kwak

It’s been widely noted that financial reform is now entering a new phase as the action moves from Congress to the regulatory agencies that will write the hundreds of rules necessary to implement the reforms. During the congressional fight, the financial sector had a huge advantage in money and lobbyists, but we had one advantage: the fact that there was (from time to time) a lot of media coverage, and Congressmen care at least a little about public opinion.

In the rule-writing phase, the banks still have a huge advantage in money, lobbyists, and lawyers–and are hiring as many ex-regulators as they can to press their case. As our friend Jennifer Taub writes at The Pareto Commons:

What lies ahead, over the next year and beyond, will require far larger armies of lawyers, economists, finance experts and just plain able bodies and minds to monitor and influence the rulemaking process. Rumor has it that one bank alone plans to set up 100 teams of employees, tasked with particular rule makings. And that is just one bank.

Unfortunately, however, the pressure of the public spotlight is largely off, tilting the battlefield in favor of industry.

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Why Agencies Get Things Terribly Wrong

By James Kwak

There has been a lot of criticism of regulatory agencies in the past couple of years, from the Office of Thrift Supervision and the Securities and Exchange Commission (Madoff who?) to the Minerals Management Service. But most of the people in these agencies are not evil; on the contrary, I believe (without a ton of evidence in support at the moment) that a majority are conscientious, hard-working, and civic-minded, and a significant minority are actually quite good at what they do. So why do they get things so wrong?

A few days ago, Leslie Kaufman of The New York Times wrote an article describing how the Fish and Wildlife Service “signed off on the Minerals Management Service’s conclusion that deepwater drilling for oil in the Gulf of Mexico posed no significant risk to wildlife.” This sounds like classic incompetence, or corruption, or both.

But the report itself, it seems, was not so far off, at least in its details. The report assessed spills of up to 15,000 barrels of oil. As Kaufman paraphrases,

“In its 71-page biological assessment, the Minerals Management Service concluded that the chances of oil from a spill larger than 1,000 barrels reaching critical habitat within 10 days could be more than 1 in 4 for the piping plover and the bald eagle, as high as 1 in 6 for the brown pelican and almost 1 in 10 for the Kemp’s ridley sea turtle. When the model was extended to 30 days, the assessment predicted even higher likelihoods of habitat pollution. . . .

“‘Heavily oiled birds are likely to be killed,’ the assessment said.”

Fifty-one days after the well explosion, the amount of oil spilled is probably somewhere between one and three million barrels.

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Regulatory Capture Underground and At Sea

By James Kwak

First there was the financial crisis. Then there was the West Virginia mine explosion. Now we have the BP oil leak. In each case, we were treated to news stories about the cozy relationships between the industry and the regulators who were supposed to be regulating it. (Here’s the latest New York Times story on how the Minerals Management Service was captured by industry — a problem that has existed for a long time, but that the Obama administration apparently did little to fix.)

Occasionally people say that the story we tell in 13 Bankers is really the same in every industry. That would not surprise me. I do think that the financial sector is unusual for a couple of reasons. One is that the interconnections between the major financial institutions make each one too big to fail in a way that, say, Enron was not. Another is that modern finance is so complex that it makes it easier for industry lobbyists to run roughshod over congressional opponents. But the problem of regulatory capture is obviously not restricted to finance, and it is a problem that we are seeing all over.

I’ve been meaning to write about this, but I haven’t had and won’t have the time. Arianna Huffington wrote an article on the parallels between the financial crisis and the West Virginia mine disaster. Lawrence Baxter has two recent posts (on his new blog) on regulatory capture and the role of regulation. Obviously this problem is not easily solved, especially in the wake of the Citizens United decision, which gave corporations even more influence over our political life. But hopefully the BP oil leak will produce a wave of anger — and a demand for answers — similar to what the financial crisis gave rise to.

Doing Discounting Wrong

By James Kwak

Ezra Klein focuses on this passage from  John Judis’s review of regulatory policy in the Bush and Obama years:

“Bush stopped weighing the costs and benefits of deregulation and issued an executive order allowing OIRA to intercede before agencies made their initial proposals, thereby providing industry lobbyists with a back door to block regulations. OIRA also instructed agencies to discount the value of future lives in constructing cost-benefit analyses by 7 percent a year, so that 100 lives in 50 years would only be worth 3.39 current lives. (Such logic can be used by conservatives to argue that the present cost of regulating greenhouse gases outweighs the future benefits of stopping climate change.)”

There is a normative argument against valuing lives in cost-benefit analysis; some people think it’s just wrong. I don’t agree with that; I think that in practice, you either value lives implicitly or you do it explicitly, and so you might as well do it explicitly. And for what it’s worth, the practice of valuing lives is firmly entrenched in our legal system; the amount you pay in damages if you kill someone negligently depends primarily on that person’s future earning potential, and also on the monetary value of the benefits that other people gained from his or her life.

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Too Big to Regulate?

This guest post was submitted by Peter Fox-Penner, a leading expert on regulation at The Brattle Group.  The views expressed herein are those of the author alone. 

At present, the debate among economists over whether our financial regulations should protect institutions on the basis that they are “too big to fail” (TBTF) still rages.  Like many other economists, I distrust the reasoning behind the TBTF justification and rue the fact that the measures taken to prop up the U.S. financial system have made the largest banks even larger, while small banks are failing at record levels.  In my first guest post I argued patchwork attempts to strengthen financial regulation without a “clean sheet” review were likely to be inadequate.

In this second post I look past short term bailouts and address the broader issue of establishing regulation of TBTF firms.  Policymakers are faced with challenge of establishing a large regulator that retains the specialized expertise needed to manage complex markets – specialization more often found in a network of smaller agencies.  To do so they will need to address the size and complexity of the financial sector itself.  As before,  I turn to examples from the utility industry, specifically the establishment and repeal of the Public Utility Holding Company Act of 1935 (PUHCA), that provide lessons for crafting regulation of complex industries.

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No to Bernanke

The American Economics Association is meeting in Atlanta, where Simon says it is frigid. I went to an early-January conference in Atlanta once. There was a quarter-inch of snow, the roads turned to ice, and everything closed. All flights were canceled, so I and some friends ended up taking the train to Washington, DC, which had gotten two feet of snow, and eventually to New York.

Paul Krugman’s speaking notes are here. Ben Bernanke’s are here.

Bernanke’s speech is largely a defense of the Federal Reserve’s monetary policy in the past decade, and therefore of the old Greenspan Doctrine dating back to the 1996 “irrational exuberance” speech–the idea that monetary policy is not the right tool for fighting bubbles. The Fed has gotten a lot of criticism saying that cheap money earlier this decade created the housing bubble, and I think it certainly played a role.

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Slow Cat, Fast Mouse

One of our readers pointed me to a paper by Edward Kane with the unfortunately complicated title “Extracting Nontransparent Safety Net Subsidies by Strategically Expanding and Contracting a Financial Institution’s Accounting Balance Sheet.” The paper is an extended discussion of regulatory arbitrage — not the specific techniques (such as securitization with various kinds of recourse) that banks use to finesse capital requirements, but the larger game played by banks and their regulators. This is how Kane frames the situation:

“Regulation is best understood as a dynamic game of action and response, in which either regulators or regulatees may make a move at any time.  In this game, regulatees tend to make more moves than regulators do.  Moreover, regulatee moves tend to be faster and less predictable, and to have less-transparent consequences than those that regulators make.

“Thirty years ago, regulatory arbitrage focused on circumventing restrictions on deposit interest rates; bank locations; charter powers; and deposit institutions’ ability to shift risk onto the safety net.  Probably because regulatory burdens in the first three areas have largely disappeared, the fourth has become more important than ever.  Today, loophole mining by financial organizations of all types focuses on using financial-engineering techniques to exploit defects in government and counterparty supervision.”

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Steve Randy Waldman on Financial Regulation

I would like to strongly recommend Steve Randy Waldman’s recent post on “Discretion and Financial Regulation.” He begins like this: “An enduring truth about financial regulation is this: Given the discretion to do so, financial regulators will always do the wrong thing.” It gets better from there.

In fact, I’d recommend it over anything I’ve written this morning, so why don’t you head over now.

By James Kwak

Regulatory Arbitrage 2.0

Gillian Tett has the latest perspective on a curious deal that Barclays did earlier this week (hat tip Brad DeLong). The deal goes something like this. Two former Barclays execs are starting a fund called Protium Finance. Protium has two equity investors who are putting in $450 million. Barclays is lending Protium $12.6 billion. Protium is using the cash to buy $12.3 billion in what we used to call toxic assets from Barclays. Protium’s 45 staff members get a management fee of $40 million per year (presumably from the equity investors, although that seems steep). Returns from the investments will be paid as follows, in this order (and this is important): (1) fund management fees; (2) a guaranteed 7% return to investors; (3) repayment of the Barclays loan; and (4) residual cash flows to the investors.

Barclays emphasized that it was not participating in regulatory arbitrage, because it is keeping the toxic assets on its balance sheet for regulatory purposes. That is, because it has a lot of exposure to those assets through its huge loan, it will continue to hold capital against those assets. So far so good.

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Boring and Exciting Finance

Taunter has a comprehensive proposal about how to regulate financial services, dividing them into Boring and Exciting.  Boring services are the following:

  • retail deposits
  • loans to retail customers, including mortgages
  • retail insurance, including annuity products
  • any custodial service beyond traditional settlement (i.e., if you hold something after T+3, you’re a custodian)

If you do any of those, then you are a Boring institution, you can do all Boring services, you face some significant regulations, and you get bailed out when necessary. If you do none of those, then you are an Exciting institution, you can do almost anything you want, and there is an ironclad rule preventing the government from bailing you out. Boring institutions cannot offer Exciting services (I think) and Exciting institutions cannot offer Boring services (that’s certain).

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