Regulation in the United States reached its high point in the 1930s, with the collapse of the old order of capitalism, the deep and long depression, the successes of unionization, the spread of leftist and reformist thought, the creation of new regulatory agencies like the Securities and Exchange Commission (SEC), and activation of old ones like the Department of Justice’s antitrust division. Very important in the relative success of the new and renewed regulation was the discrediting of the old regime, with some of the leading financiers really excoriated in the Pecora hearings and a number, including a former head of the New York Stock Exchange, actually hauled off to jail. Orthodox thought about the ability of "free" markets to take care of everything was prostrate; interventionist thought surged with theories of imperfect competition and of business cycles and macro-instability, culminating in J.M. Keynes’s General Theory of Employment, Interest and Money in 1936, that called for systematic government fiscal offsets to keep the unstable capitalist ship afloat. In this intellectual and political environment, the new and revived regulatory agencies were treated with considerable respect. Although subjected to abuse and obstruction by the old establishment, they not only had the power to act, they also attracted quality staff and strong leaders—notably, later Supreme Court Justice William Douglas as SEC chair and Thurman Arnold as head of the antitrust division.
Regulation went into a slow decline in prestige and power after World War II and took a sharper downturn in the Reagan era and through the Bush-Cheney years. Regulation in the United States has always suffered from the influence of the regulated in personnel selection, including an active revolving door between regulators and industry and via legislative constraints and budgetary blackmail or rewards—cuts if aggressive and uncooperative; rewards if responsive to industry wants.
Scandals get the media’s and public’s attention, but only briefly, whereas the regulated industries maintain continuous attention to the regulatory process and work steadily, and with substantial resources, to limit its effectiveness in the public interest. It was long recognized that during its lifetime the now-defunct Interstate Commerce Commission was the most generously funded regulatory agency, based on its feeble public service direction and virtual industry capture (by railroad and, later, trucking interests).
As regards regulatory law, there have always been friendly legislators who would help make the law loophole-ridden or with ambiguities that would permit delays, litigation, and resolutions of conflict satisfactory to the interests of the regulated.
Regulation has suffered more severely under Republican than Democratic rule, with especially savage setbacks under Reagan and George W. Bush. But the Democrats have failed to compensate for prior Republican damage, so the regulatory ship has slowly foundered. Carter deregulated the airlines and trucking industry while Clinton not only failed to resuscitate the damaged FCC, he reappointed Ayn Rand disciple and financial bubble-facilitator Alan Greenspan to the Fed’s chair. With the conflict-of-interest-laden advice of Robert Rubin and Larry Summers, Clinton did nothing to contain the growing derivatives menace and engineered the repeal of the Glass-Steagall Act. Self-regulation was the watchword, aided of course by the supposed discipline of competition.
Very important in the process of weakening regulation was the changing ideological environment, with the rise of the Chicago School of Economics, the decline of liberal Keynesianism and its partial displacement by Military Keynesianism, and the associated triumph of markets-can-do-it-all neoliberalism. The Chicago School was (and remains) aggressively hostile to regulation, with Milton Friedman, George Stigler, Sam Peltzman, Ronald Coase, George Benston, Gary Becker, and others arguing vigorously for the great efficiency of uncontrolled securities and merger markets and the desirability of their deregulation (see "The Politicized Science" in Herman, Triumph of the Market, South End Press, 1995). In a much-cited article in 1964, George Stigler attempted to prove quantitatively that SEC regulation had not made security markets less volatile and otherwise more efficient than in the years prior to the creation of the SEC ("Public Regulation of the Securities Markets," Journal of Business, April 1964). It was one of my more pleasurable academic experiences to have been able to demonstrate statistically that Stigler had massaged the data: 24 of his 25 data errors served to support his preferred conclusion, which when corrected supported the opposite conclusion—that SEC regulation had improved market performance (Irwin Friend and Edward Herman, "The SEC Through a Glass Darkly," Journal of Business, July 1964). This was the year Stigler served as president of the American Economics Association.
The Chicago School and its ideology has suffered heavy blows over the past several decades: the failure of monetarism as a policy guide; the failure of freed exchange rates to stabilize international exchanges; the collapse of the Pinochet dictatorship in Chile; the recent stock market and housing bubbles and their bursting; and the associated decline and discrediting of more fundamental free market theorizing like "rational expectations" and the "efficient markets" hypothesis. This ideological collapse was epitomized in Greenspan’s belated pathetic admission that he had not only been wrong, but still didn’t understand what happened and why: "Those of us who have looked to the self-interest of lending institutions to protect shareholders equity, myself included, are in a state of shocked disbelief" (Edmund L. Andrews, "Greenspan Concedes Flaws in Deregulatory Approach," NYT, October 24, 2008).
One thing the Chicago School got right was their theory of regulatory capture. But they never linked their idea that regulators were likely to be captured by the regulated to their analyses of why regulation might not be very effective. We may be sure that they never urged an enhanced democracy that would be alert to the capture threat, prevent it, and assure that public-spirited people were put into regulatory office. Actually, one of the founders of the Chicago School, Henry Simon, in a booklet published in 1932 entitled "A Positive Program for Laissez-Faire," did argue that if efficiency required firms to be too big to sustain competition, they should be nationalized rather than regulated or left as a private monopoly. But that was an early and more honest Chicago School. The Friedman-Stigler version of the post-World War II years, that would eventually love the Pinochet military dictatorship of Chile, could never support nationalization—they would prefer private monopoly.
We are now in an age of attempted re-regulation, with widespread recognition that the regulatory system had been under-nourished and dismantled at great cost. But it is not likely that a new regulatory apparatus will be constructed that will be able to cope with contemporary problems. One reason for this is the greater complexity of the financial world, with the executives of the financial institutions sometimes admittedly unable to keep up with the rapidly evolving new instruments and tricks of the trade produced by their technical whizzes and their global scope making them still harder to follow and regulate. Regulators do not have the resources and expertise to cope with these challenges. This is a result in part of the fact that regulatory service is neither honorific nor well-paid and, of course, is still hardly free from being compromised or undermined by industry-friendly legislators, executive politicians, and courts now well-packed with right-wingers. The revolving door, which reached a high level under Reagan and the Bushes, is hardly gone and the number of former legislators and legislative staffers now serving as industry lobbyists is at a very high level. (In a recent study, 243 just for the 6 largest banks and their trade associations.) All of this erodes the morale of public-spirited regulators and leads to a further exodus, positively desired in a Reagan/Bush regulatory environment.
The problems, including the revolving door, have not been resolved by the election of Barack Obama. Timothy Geithner and Lawrence Summers, key appointees in the financial regulation field, had records of closeness to the leaders of the financial sector that did not promise well for any reform with bite, and we have not gotten any. Recent attention has focused on Ken Salazar, a right-leaning Democrat and rancher selected by Obama as Secretary of the Interior, to the dismay of environmentalists and gratification of business. Salazar failed to move quickly, or at all, in cleaning up what a 2008 internal review by the Interior department of its Minerals Management Services Unit (MMS) called a "a dysfunctional organization that has been riddled with conflicts of interest." Salazar was hardly the person to end what Obama called a "cozy relationship" between MMS and the oil industry. In fact, Salazar hired as deputy administrator for land and minerals management former British Petroleum (BP) executive Sylvia B. Vaca. And under Obama and Salazar, MMS continued to give BP a steady stream of exemptions from required environmental impact studies.
The decline of regulation and the difficulty of resuscitating it rests heavily on the structural changes that have strongly impacted politics and the media as well as regulation. Greater inequality of wealth and the enhanced importance of finance have fed into politics, paralyzing the Democrats as the erstwhile reformist party and making it virtually impossible to engage in serious structural or regulatory change. The changes required run into previously mentioned complexity and globalization problems. Adrian Blundell-Wignall, a special adviser to the Organisation for Economic Co-operation and Development, said recently that the "most basic lesson of the crisis" was that "we need to separate capital market banking from standard commercial banking" in order to make incentives and regulation manageable. And we need to control leverage on a global basis to prevent the circumvention of the regulation of risk-taking. But Blundell-Wignall suggests that these essential reforms seem to be blocked by the "institutional capture" of policy-makers by the leading global financial institutions (Larry Elliott, "Banking split, essential to avoid new financial crisis, warns OECD adviser," Guardian, May 27, 2010).
The current financial regulation bills in the United States do not split the capital market from commercial banking, which would entail a return to Glass-Steagall; they do not reduce the size of financial institutions; they provide no fixed limits on leveraging; and they do not deal with the problems that will arise from the absence of such limits abroad. They are what Joe Nocera calls "oh-so-reasonable" bills, "as if Congress…would—heaven forbid!—upset the banking industry" ("Dubious Way To Prevent Fiscal Crisis," NYT, June 5, 2010).
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Edward S. Herman is a professor emeritus of finance at the Wharton School, University of Pennsylvania. He has written extensively on political economy, foreign policy, and media analysis. Among his books are The Political Economy of Human Rights (with Noam Chomsky, South End Press, 1979); Corporate Control, Corporate Power (Cambridge University Press, 1981); The "Terrorism" Industry (with Gerry O’Sullivan, Pantheon, 1990); The Myth of the Liberal Media: An Edward Herman Reader(Peter Lang, 1999); and Manufacturing Consent (with Noam Chomsky, Pantheon, 1988 and 2002).
