But Why Didn’t Regulators Regulate?

Bethany McLean mostly misses with her column in The New York Times on who’s really to blame in the sordid Abacus scandal.

Yet, in the end, it comes down to this: Goldman Sachs, ACA Capital, IKB Deutsche Industriebank and even the rating agencies never had any duty to protect us from their greed. There was one entity that did — our government.

She goes on to make the legitimate point that regulators didn’t regulate—and she even brings up that the OCC and OTS actively prevented crackdowns on predatory lending by the states, which Secretary of the Audit Dean Starkman has emphasized.

But the government-did-it argument swallows its own tail. Why didn’t regulators regulate?

Ever heard of regulatory capture? Well then, who captured regulators like the OCC and OTS? That would be the financial industry, led by the likes of Goldman Sachs (yep, an Audit funder). The financial industry didn’t want them to regulate. It really boils down to that. Wikipedia actually has a pretty great description of regulatory capture. This is the first two paragraphs of the entry on regulatory capture:

Regulatory capture occurs when a state regulatory agency created to act in the public interest instead acts in favor of the commercial or special interests that dominate in the industry or sector it is charged with regulating. Regulatory capture is a form of government failure, as it can act as an encouragement for large firms to produce negative externalities. The agencies are called Captured Agencies.

For public choice theorists, regulatory capture occurs because groups or individuals with a high-stakes interest in the outcome of policy or regulatory decisions can be expected to focus their resources and energies in attempting to gain the policy outcomes they prefer, while members of the public, each with only a tiny individual stake in the outcome, will ignore it altogether. Regulatory capture refers to when this imbalance of focused resources devoted to a particular policy outcome is successful at “capturing” influence with the staff or commission members of the regulatory agency, so that the preferred policy outcomes of the special interest are implemented.

Anyone want to deny that that’s exactly what happened over the last thirty years or so? Even the ideological movement that provided the theoretical underpinning for gutting regulation had to get funded somewhere.

Here’s McLean:

More important, it was Congress that sat by idly as consumer advocates warned that people were getting loans they’d never be able to pay back. It was Congress that refused to regulate derivatives, despite ample evidence dating back to 1994 of the dangers they posed. It was Congress that repealed the Glass-Steagall Act, which separated investment and commercial banking, yet failed to update the fraying regulatory system.

Again, why did Congress refuse to regulate derivatives? Why did it repeal Glass-Steagall? It didn’t do it for you and me.

The problem here is the reliance on the gubmint boogeyman—as if it’s this self-directing entity operating in a vacuum. It’s appealing shorthand, and the government deserves a heaping helping of blame, but it’s misdirection, too. The government, in not regulating the financial industry, was acting not as a government of the people but of the financial industry—the one that paid for its campaigns and waited on the other side of a gold-plated revolving door.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.