For 30 years, the U.S. political system has been tilted in favour of business deregulation and against new rules. But that is about to change, now that the government has been forced to intervene in the once highflying financial industry to avert an economy-wide crash.
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Financial Crisis May Give Rise to New Era of Regulation
By Jackie Calmes
13 October 2008
For 30 years, the U.S. political system has been tilted in favour of business deregulation and against new rules. But that is about to change, now that the government has been forced to intervene in the once highflying financial industry to avert an economy-wide crash.
An expansion of the government’s role in financial markets is certain: On Friday, the Treasury Department updated its recommended reforms of the existing regulatory structure, which it will leave to the next president and Congress. Congressional leaders and both presidential candidates already have their own, more far-reaching ideas, from further restricting executives’ pay to remaking the entire regulatory structure so that it better supervises both traditional activities and newer ones, like credit-default swaps, that are unregulated.
But the pro-regulation climate will probably spill over into other sectors. That seems especially likely now that the Treasury and the Federal Reserve are pumping money into corporations of all types to shore up their capital and to finance day-to-day operations until credit markets recover, and with the auto industry separately getting billions of dollars in government assistance.
That will give impetus to those who seek new measures to address climate change, or who want health care mandates to expand insurance coverage and restrain costs, or who are calling for new safeguards for food, prescription drugs and toys from China and other less-regulated trading partners.
“We now have a collective anger, disgust, over our whole financial system and it’s obvious we’re going to get a regulatory backlash,” said Robert Litan, an economist at the Brookings Institution who has studied financial and regulatory issues for decades. “And we know it’s going to come in a big way in 2009.”
Litan predicted a spill over effect to other industries because, among the voters, “the gestalt out there is, big companies are animals and they need to be put in their cages.” He added, “The only open question going forward in this new era is: ‘Are we going to overdo it? Is the pendulum going to go completely over in the other direction?”‘
Whatever policies result, the political fallout of this renewed respect for government regulation is evident in the current election campaigns.
Democrats, who typically have been on the defensive in recent decades as the more pro-regulatory party, now are playing offense. Senator Barack Obama, the Democratic presidential nominee, is leading his party’s charge, blaming Republicans and their candidate, Senator John McCain, for the lax oversight that contributed to the financial crisis. Obama recently charged that McCain supports an economic theory “that basically says that we can shred regulations and consumer protections.”
The Senate Republican leader, Mitch McConnell, unexpectedly fighting for re-election in Kentucky, is the target of a television ad that says, “Wall Street and the big banks gave Mitch McConnell $4.4 million for his campaigns, and he fought for less regulation of Wall Street.”
Yet Republicans, led by McCain, are promising that they, too, will support toughened government regulations.
“I think we’re going to have to see smarter regulation,” McCain’s chief economic adviser, Douglas Holtz-Eakin, said during an interview.
Others are more cautious about the prospect for a major shift in political attitudes toward regulation. Sam Peltzman, a University of Chicago professor and free-market conservative who is widely considered the intellectual godfather of deregulation, said the outlook did not depend solely on who is elected.
“It depends on the economy itself,” he said, adding that the government under either party’s control would not likely impose costly regulations on business in bad times.
For example, Peltzman noted that McCain and Obama are both committed to action against climate change, through a mix of regulations and market forces.
“But I think it will be put off because of a slowdown in the economy,” he said. And as for health care, “that depends a lot on how strong the Democrats are in Congress.”
There will be no putting off the action on re-regulating finance. Both presidential candidates and congressional leaders like Christopher Dodd of Connecticut, the Senate Banking Committee chairman, and Barney Frank of Massachusetts, chairman of the Financial Services Committee of the House of Representatives, would go further than the Treasury has proposed. They say they want to overhaul the current system next year to get rid of overlapping regulatory agencies, give other agencies new powers and perhaps create a new overseer to monitor the whole system.
Financial institutions are likely to face tougher rules on maintaining capital and liquidity. Companies and instruments that currently are not regulated could be brought under the government’s thumb. Unregulated derivatives, hedge funds, mortgage brokers and credit-rating agencies all have been implicated in the current crisis.
Both Democrats and McCain talk of slapping limits on executives’ compensation, while Democrats would also give shareholders more say about who sits on corporate boards. Obama, if he is elected president, would join with the congressional Democrats, who are likely to increase their majorities in the House of Representatives and the Senate, to revive their unsuccessful proposals to impose new penalties for predatory lending, including for mortgages.
There are proposals for a new agency to protect consumers against a variety of financial abuses, involving mortgages, auto and student loans, and credit cards. Credit card companies’ marketing, billing and high interest rates will likely be reviewed. The insolvency of the insurance giant American International Group is reviving talk in Congress of seeking U.S. regulation of the insurance industry, which prefers its current, mostly friendly patchwork system of state oversight.
The financial industry “is not the only area where the deregulation ideology got completely out of hand,” said Representative Henry Waxman, the California Democrat who is chairman of the Oversight and Government Reform Committee in the House. While Waxman is already holding hearings on the financial crisis and possible new regulations, he said, “I’m looking forward to working on” issues like climate change and health care insurance in coming years.
Waxman, who was first elected from California in 1974, said he did not believe the economic downturn would impede new regulations.
“Over the years, I’ve heard industry after industry come in and say, ‘We cannot survive economically if we have these regulations,’” he said. Instead, he argued, studies showed that their compliance was less costly than predicted, and companies emerged more efficient and competitive.
While the political stereotypes portray Democrats as favouring regulation and Republicans as deregulators, recent history is more complicated.
A Republican. President Richard Nixon, presided over one of the most active regulatory periods of the past half-century, working with Democrats who controlled Congress in the early 1970s. His legacy includes the Environmental Protection Agency, the Consumer Product Safety Commission and the Occupational Safety and Health Administration.
Later in that decade, a Democrat, President Jimmy Carter, launched the deregulatory era that has continued with notable breaks to the present. While people in both parties associate his Republican successor, Ronald Reagan, with making regulation a dirty word politically, it was the Carter administration that instituted cost-benefit analyses for new regulations and deregulated the airline, railroad and trucking industries.
Reagan’s record was more anti-regulation than deregulatory. He and President George H.W. Bush fought congressional Democrats’ charges that they were not enforcing environmental and other regulations. In political campaigns, the Republicans made gains in part by painting Democrats as the party of big government. However, studies showed that the number of regulations spiked under the first President Bush, due in part to new regulations after the savings and loan scandals of the late 1980s. Also, Bush signed into law a new clean air act, a nutrition-labelling law and the landmark Americans with Disabilities Act, among others.
The conservative analyst Bruce Bartlett, a Treasury official at the time, said that Bush was so angered by a 1991 magazine report headlined “The Regulatory President” that he ordered a moratorium on all new regulations. Sixteen years later, the same magazine, The National Journal, ran a similar article about Bush’s son, calling George W. Bush “the biggest regulator since the Nixon-Ford years.”
That record, however, mostly reflects the many new homeland security regulations put in place since the terrorist attacks of Sept. 11, 2001. In other areas, the current President Bush moved more aggressively than his father and Reagan away from enforcing existing regulations, choosing to rely on the financial services industry and manufacturers, among other groups, to self-regulate.
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