Watching the Watchmen
Why economists suspect regulators and regulation
I've written before about public choice theory, talking about how the US federal government's longstanding subsidy for domestic sugar production embodies the essential point about the disproportionate power in political systems of highly concentrated interests over the diluted ones.
Today I want to add two additional examples, and this link to the essential George Stigler study which fleshes out the public choice theory of regulation. News comes via Ezra Klein of The Washington Post's "Wonkbook" blog that the Commodity Futures Trading Commission has failed to complete cost-benefit analysis for a host of regulations it is writing to flesh out the Dodd-Frank Act.
Quelle surprise. This comes on the heels of similar news last year from the Environmental Protection Agency that it, too, decided that a cost-benefit analysis was too time-consuming and that, you know, it would be a whole lot better if it could just write rules which apply to other people without considering such insignificant things as consequences.
The failure of both these agencies to regulate correctly was predictable. In fact, the total disaster which is emerging from Dodd-Frank was more predictable than anything -- it is hard to think of an industry with more concentrated influence in government than finance. It's why I'm deeply suspicious of comments like this one from a recent Tim Geither op-ed in The Wall Street Journal:
Is there some risk that these reforms will go too far with unintended consequences? That depends on the quality of judgment of regulators in the coming months as they flesh out the remaining reforms. But our system provides considerable protection against that risk, with the rules subject to long periods of public comment and analysis and with room in the law to get the balance right.What we are going to end up with, in both cases, are systems programmed to be irrationally risk-averse. The regulators are punished when things they promised wouldn't happened do, not when they prevent too much from happening. Their incentives are twisted by the political process.
The stability-at-all-costs interest is tremendously powerful: it helps the regulators, whose apparent power to prevent bad outcomes is confirmed, and it helps the industry, as higher barriers to entry and competition are established. The diluted interest is hurt, and in many of the cases for Dodd-Frank, the diluted interest are those marginal participants in the financial system: those who financial firms used to consider "risky" but now flat-out deny for credit cards, mortgages, car loans, etc. Given the costly government protections and interventions, they have been rendered unprofitable -- conversely, the remaining profit opportunities receive greater attention, which those who already benefit most from the financial system. I think the major shift in this recession to financial risk aversion may prove more secular, i.e. permanent, than most economists expect.