How the Regulators Failed

The Financial Crisis Inquiry Commission Report paints a disturbing picture of the federal agencies tasked with overseeing America’s financial sectors.

At least from what I’ve read of it so far—and, no, I haven’t finished all 662 pages—the Financial Crisis Inquiry Commission Report paints a damning and disturbing picture of the federal agencies tasked with overseeing America’s financial sectors. The lack of a consensus on the Commission--the Republicans and Democrats both voted in blocks and differed on key points--means that historians and economists will have the final word on the causes, consequences, and chances of avoiding the 2008 financial crisis. At a glance, however there’s one key point where a rough consensus seems to exist: “regulatory capture” played a key role in the financial crisis.

Regulatory capture, a theory largely developed by Nobel laureate George Stigler, posits that regulatory agencies often get “taken over” by special interest groups. Quite simply, groups that have a particularly large amount to gain from a certain regulatory outcome will devote lots of resources to determining those outcomes: they’ll donate to sympathetic politicians, recruit former regulators, and do everything they can to determine regulatory actions.  Although the academics who developed it described the theory in dispassionate, sometimes boring terms, it’s enormously misused by segments of both the Left and the Right. Those on the Left—particularly of the Ralph Nader camp--often claim that “big business” necessarily dominates regulators and, as a result, only trial lawyers and self-anointed consumer advocates groups can be trusted to intervene on behalf of the “true” public interest.  An equally silly theory gets pushed by some on the libertarian right: because regulatory capture can happen, giving almost any government body the right to press any regulation (besides a criminal law) necessarily does public harm. This misses the point on the theory: the theory is basically neutral on the nature of the groups doing the capture but simply posits that having regulators serve particular interest groups rarely advances the public interest.

Neither side of the Commission embraces either of these extremes. Instead, one core dispute seems to be over who captured the regulators. The Republican dissents largely blame the political process—the homeownership agendas pushed by the Clinton and Bush administrations—whereas the Democrat majority opinions largely put the blame on Wall Street firms. As the report—mostly written in pretty reasoned language itself concedes—the crisis had no single cause.

But, at a glance, the report, if nothing else, should be taken as a clarion call to build structures resistant to regulatory capture.

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