A big story in the news this week was on “regulatory capture,” a relatively foreign term to many outside the field of economics. NPR aired secretly taped recordings between bank examiners from the New York Federal Reserve and executives at Goldman Sachs, exposing the regulators as timid and deferential to the bankers. The tapes suggest federal regulators had “become more oriented to the institution they are supervising than to representing the public interest.” The very definition of regulatory capture.
More importantly than the standard definition of “regulatory capture,” though, situations like this display the larger, systemic problem of design of institutions.
According to Vox.com, “The scandal is less about Goldman’s behavior and more about the Fed’s inability or unwillingness to uphold the rule of law. Reasonable people can debate whether specific regulations are necessary, but even the best set of rules is totally insufficient if paired with an enforcement system that applies them inconsistently or not at all. Fair and consistent application of regulations is a prerequisite for having a regulatory regime of any kind. When regulators act the way the TAL/ProPublica report show New York Fed regulators acting, it suggests that we need to reform or revamp regulatory institutions before we can expect any new rules they’re charged with enforcing to do much of anything.”
This story raises the question: What is the best way for an agency to ensure industries comply with regulations?
If a federal agency wants to create a rule, they can enforce the rule by A) monitoring the industry through each step to reach the desired outcome or by B) ensuring that the industry achieves the outcome. In the Goldman Sachs story, the Federal Reserve followed the first option, and the agency’s rigged, time-consuming process of monitoring became an institutional problem, susceptible to the influences of the bankers. Examples like this, therefore, appear to give credence to the need for greater flexibility within the regulatory process; an approach more like option B.
Endemic problems of regulatory capture should remind us that the outcome of a regulation is more important than the process or means of regulating. As a result, flexibility in pursuit of the right outcomes should be a virtue for the regulated and regulators alike.