The Push to Regulate Markets

There's a lot of talk about the need to regulate product and financial markets, and how to avoid overreaction or favoring special interest groups in the process. First, Jim Hamilton:

Catch the wave, by James Hamilton: ...I don't always agree with Representative Barney Frank (D-MA), but I thought his remarks in yesterday's Boston Globe were right on target:

Well-functioning financial markets depend on transparency and confidence that institutions are playing by clearly defined rules. Both were in short supply in the months leading up to the August meltdown and remain so today. Large pools of unregulated capital, often highly leveraged, especially in hedge and private equity funds remain opaque and have been joined by massive sovereign investment funds to transform the financial landscape in ways that are out of reach of regulators here at home and in other wealthy countries. We lack the information that we need to ensure safety and soundness as well as the confidence that comes from the requirements mandating governance and reporting standards that apply to publicly traded companies.

To an important extent these new pools of capital are structured in a fashion that allows them to avoid the scrutiny that is required of firms and financial institutions in the regulated sectors. We should not be surprised. It is a fact of life that investors and firms will seek to innovate their way around whatever regulatory strictures apply, whether they deal with health and safety, labor protections, or reporting obligations. This tendency has been exacerbated by a 30-year attack on the very notion of a regulatory role for governments and loud professions that the market not only knows best, but knows everything.

Our job is to understand the changes in the financial marketplace and consider what we must do to ensure that our regulatory system is able to keep up with those changes. Innovation is as important in financial markets as it is in product markets, but it would be foolish to act as if regulatory structures, designed for a different world, do not have to be as nimble and innovative as those they regulate.

On the other side of this argument we seem to have Fed Chair Ben Bernanke, who argues that lenders have learned their lesson and these problems are being corrected on their own. Now, I happen to believe there is also a lot of truth to what Bernanke is saying here as well. But I would invite those in the Federal Reserve to look a few months down the road and ask how this discussion is going to play out if, as I fear likely, the financial consequences of previous reckless real estate lending continue to grow. Each new report of another failed institution, another family losing their home, another pension fund without the money to pay the retirees, and another decline in real estate prices is going to mean more pressure for the kinds of changes that Representative Frank has called for, and burn more of the political capital of anyone who tries to argue against them.

While I agree with what Representative Frank had to say, the devil is in the details. I would vastly prefer to have the staff at the Federal Reserve craft these reforms. But doing so requires the Fed to get on board now to try to set the direction for this debate, before they get swept aside by a political tsunami. ...

Not everyone trusts the Fed to impose the needed regulation, but I agree that the Fed is better suited for the task than congress and also hope the Fed will step in and regulate these markets as needed to ensure they function smoothly. My biggest worry is an overreaction that cuts off credit to people who traditionally have had trouble finding anyone to lend to them.

When it comes to other federal agencies, those in charge of regulating product markets, I would also like to see more reaction to the recent push for regulation and testing of toys, food, etc., and the reasoning is similar. But while it would be best if federal agencies would step in and provide the needed regulation in areas such as food and product safety, they are not very willing to do so. The competence is there - most of these agencies have very qualified (apolitical) staff working for them - but the current leadership in these agencies is generally very much opposed to regulating the marketplace. Sometimes the opposition is justified since industry will attempt to use these kinds of rules as protectionist measures, and markets will self-correct in response to problems in many cases. But opposition is not always justified and I would prefer to see federal agencies step in and act to preempt legislators who may not fully comprehend the economic issues, and who are subject to capture by special interest money, both of which can work against legislation that best protects the public interest:

In Turnaround, Industries Seek Regulations, by Eric Lipton, NY Times: After years of favoring the hands-off doctrine of the Bush administration, some of the nation’s biggest industries are pushing for something they have long resisted: new federal regulations.

For toys and cars, antifreeze and fireworks, popcorn and produce and cigarettes and light bulbs, among other products, industry groups or major manufacturers are calling for federal health, safety and environmental mandates. Some of those industries are abandoning years of efforts to block such measures, often in alliance with the Bush administration, which pledged to ease what it views as costly, unnecessary rules.

The consequences for consumers, though, are not yet clear. The tactical shift by industry groups is motivated by a confluence of self-interests: growing competition from inexpensive imports that do not meet voluntary standards, and a desire to head off liability lawsuits and pre-empt tough state laws or legal action... Concerns that Democrats could soon expand their control in Washington has also prompted manufacturers or producers to seek regulations that they consider the least burdensome, regulatory experts say. ...

Rick Melberth, director of regulatory policy at OMB Watch, a Washington group that tracks federal regulatory actions, agreed. “I have never before seen so many industries joining a push for regulation,” Mr. Melberth said. “What we need to watch closely is if this will achieve a real increase in standards and public protections or simply serve corporate interests.”

Some industries and consumer groups are aligned in seeking the same regulations... Other industries, though, are endorsing mandated government standards that fall well short of what consumer advocates want or what tougher state rules require. ...

“I am worried about industry lobbyists bearing gifts,” said Edmund Mierzwinski, consumer program director at the U.S. Public Interest Research Group in Washington. “I don’t trust them. Their ultimate goal is regulation that protects them, not the public.” ...

[I]ndustry officials, consumer groups and regulatory experts all agree there has been a recent surge of requests for new regulations, and one reason they give is the Bush administration’s willingness to include provisions that would block consumer lawsuits in state and federal courts.

Such pre-emption clauses were included, for example, in a drug label rule issued by the Food and Drug Administration in 2006 and in a new fire-prevention standard for mattresses imposed by the Consumer Product Safety Commission in July, said David C. Vladeck, a professor at the Georgetown University Law Center.

The preemptions bar consumers from filing liability claims in courts and supersede any tougher state regulations, extremely valuable protections for a major manufacturer, Mr. Vladeck said. “This is Christmas,” he said of industry, “this is their wish list.” A number of businesses are seeking such preemptions, though the clauses are being challenged in many courts. ...

While federal agencies have embraced some of the proposed regulations, in other cases they have resisted, stalled or moved slowly on them, frustrating industry groups.

“We have had a very, very uphill battle trying to get regulation,” said David H. Baker, a lawyer for the Lighter Association. The organization, representing cigarette lighter manufacturers, has been seeking a mandatory standard because unsafe, inexpensive Chinese imports were flooding the market, but staff members at the Consumer Product Safety Commission recommended against such a rule, saying the number of deaths and injuries did not justify it. ...

Last year, almost all of the nation’s spinach crop was destroyed after contaminated spinach ...sickened nearly 200 people in 26 states, killing a Wisconsin woman. It was the last straw for large growers, who now support mandatory safety standards. But the Department of Health and Human Services has been slow to endorse them, leading some proponents to conclude that the agency has objections.

“It’s a little unique when both consumer groups and industry associations are out there saying that we need new regulations, and the government doesn’t agree,” said Jenny Scott, vice president for food safety programs of the Grocery Manufacturers Association. ...