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Time for industry to end its war on regulation

Gary Quarles of West Virginia speaks to a House panel about his son's death at Upper Big Branch mine.
Gary Quarles of West Virginia speaks to a House panel about his son's death at Upper Big Branch mine. (Jon C. Hancock/associated Press)

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By Steven Pearlstein
Wednesday, May 26, 2010

The biggest oil spill ever. The biggest financial crisis since the Great Depression. The deadliest mine disaster in 25 years. One recall after another of toys from China, of vehicles from Toyota, of hamburgers from roach-infested processing plants. The whole Vioxx fiasco. And let's not forget the biggest climate threat since the Ice Age.

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Even if you're not into conspiracy theories, it's hard to ignore the common thread running through these recent crises: the glaring failure of government regulators to protect the public. Regulators who were cowed by industry or intimidated by politicians. Regulators who were compromised by favors or prospects of industry employment. Regulators who were better at calculating the costs of oversight than the benefits. And regulators who were blinded by their ideological bias against government interference and their faith that industries could police themselves.

Most of us are aware by now of how lawyers for Massey Energy were able to game the appeals system to prevent the government from closing mines such as the deadly one in West Virginia that had been cited for multiple, serious safety violations.

We all know how the Securities and Exchange Commission agreed to let investment banks set their own leverage ratios and how bankers delayed for nearly two years a crackdown on excessive lending for commercial real estate.

We've seen the e-mails from Toyota officials boasting of their successful efforts to avoid a costly recall despite numerous reports of sudden acceleration.

And on Tuesday we read a report from the Interior Department's inspector general describing how oil company employees filled out government inspection reports for their own drilling rigs in pencil so that real inspectors could just trace over the results in pen before filing them.

It hardly captures the breadth and depth of these regulatory failures to say that during the Bush administration the pendulum swung a bit too far in the direction of deregulation and lax enforcement. What it misses is just how dramatically the regulatory agencies have been shrunken in size, stripped of talent and resources, demoralized by lousy leadership, captured by the industries they were meant to oversee and undermined by political interference and relentless attacks on their competence and purpose. And it makes it perfectly laughable to suggest, as many in the business community now do, that during the first 16 months of the Obama administration the pendulum has already swung back too far in the other direction.

Yet, there they were last week, trotting out all the tired old arguments in a last-ditch effort to scuttle financial regulatory reform -- how it would stifle innovation and risk-taking, send jobs and investment overseas and dry up credit for small businesses. Those were the same excuses for not regulating derivatives trading, not regulating mortgage brokers, not regulating hedge funds, not regulating insurers and industrial finance companies, and not second-guessing the underwriting of federally insured banks. Only this time, nobody was buying it.

The big flaw in the business critique of regulation is not so much that it overstates the costs, but that it understates its benefits -- in particular, the benefits of avoiding low-probability events with disastrous consequences. Think of oil spills, mine explosions, financial meltdowns or even global warming. There is a natural tendency of human beings to underestimate the odds of such seemingly unlikely events -- of forgetting that the 100-year flood is as likely to happen in Year 5 as it is in Year 95. And if there are insufficient data to calculate the probability of a very bad outcome, as is often the case, that doesn't mean we should assume the probability is zero.

Another challenge in thinking about regulation is that any meaningful analysis has to go beyond merely toting up the costs and benefits to a consideration of how those costs and benefits are distributed. Regulations limiting derivatives trading, for example, may add costs or reduce profit for a bank or its corporate customers every year, but the benefits of that regulation would mostly accrue to taxpayers and the economy as a whole if it saves them from the occasional financial crisis that requires a bailout or triggers a recession. From the banks' standpoint, such a regulation may well seem like a bad idea, but for society as a whole it would be a winner.

It's time for the business community to give up its jihad against regulation. We can all agree that there are significant costs to regulation in terms of reduced sales and profits, stunted job growth and even, from time to time, stifled innovation. But what we should have learned from recent disasters is that the costs of inadequate regulation are even greater. Strong and efficient economies require strong and effective government oversight.


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