This guest post was contributed by Ilya Podolyako, a third-year student (for a few more days) at the Yale Law School and until recently executive editor of the Yale Journal on Regulation and co-chair, with James Kwak, of the Progressive Law and Economics reading group.
Though many economic indicators continue to look grim, the sense of crisis has largely faded from the front pages in the last few weeks. In my opinion, this is shift in demeanor of reporting is due to audience fatigue, not some fundamental change in the underlying dynamics of the economy. As the ever-prescient Onion points out, the American public has only so much tolerance for tragic stories, regardless of their source. For better or worse, however, calls for a drastic restructuring of the regulatory framework have quieted as of late. The Obama Administration has already spent a large amount of political capital on its first round of stimulus, the auto “bailouts,” and the day-to-day management of the financial sector, and will likely have to use up some more for further bank recapitalization and a possible second round of the stimulus. Unsurprisingly, in this environment, blueprints for a brand-new “systemic” financial regulator seem to have been shelved, despite a general consensus that some such entity is necessary to avoid future economic meltdowns.
This development may have some surprising upsides. For one, we have time to scrutinize the wisdom of putting enormous power into the hands of a single agency. The extant regulatory framework is certainly inadequate in many respects. Yet consolidating the exchanges, the SEC, the CFTC, the OCC, the OTS, federal housing agencies, federal consumer protection organs, a macroeconomic policy maker, a new oversight agency for derivatives, and perhaps a dedicated industrial policy manager into one body with wide-ranging authority carries enormous risks that cannot be ameliorated unless we manage to fix certain seemingly intractable underlying problems first. These include the outsize importance of the financial services sector to the U.S. economy, the permeation of government by individuals with a vested interest in preserving this status quo, and basic human fallibility and greed. Of particular concern is the possibility of regulatory capture, which takes place when a regulator begins acting for the benefit of its subjects rather than in accordance with its stated mandate of minimizing systemic risk. While any agency can theoretically be captured by concentrated and powerful individuals, a breach of the “mothership” would carry far more severe repercussions than the loss of one or two “destroyers.” Of course, only the mothership can accomplish certain tasks; in the economic context, it would exist to take on challenges of a scope that smaller bodies simply cannot handle.
Continue reading “Guest Post: Capturing the Regulatory Mothership” →