Tag Archives: regulation

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