Blog: Two Cheers for Deregulation But only two.

Irwin Stelzer

So regulation is not always a bad idea after all.

On Friday, her last day in office, Janet Yellen told Wells Fargo management that cheating millions of consumers has consequences. The bank that opened fake accounts, overcharged for auto insurance, and in other ways ignored the consequences of the incentives built into its bonus scheme has been fined and told to shake up its sleepy board. Most important, Wells Fargo will not be allowed to grow its business until it satisfies the Fed that its house is in order.

Few would quarrel with her decision, least of all Jay Powell, her Trump-appointed successor, who voted with Yellen on Friday. And even better, Yellen, not a cheerleader for Wall Street, took to the television studios to state with justifiable confidence that the downward lunge of the stock market did not create a threat to the financial system because of the strong capital positions required of the banks by-yes-regulators and their much-derided stress tests.

And deregulation is not necessarily a good idea everywhere and at every time, and the crowd cheering anything that bears that name might want to have a re-think. Yes, Trump has done a good job of cutting through the nightmarish web of regulations Barack Obama spun to control American industry. The business community no longer must wonder each day what the government plans to do to it. Good thing.

But jumping to the conclusion that all regulation is a bad thing makes no sense. When markets fail to reflect the costs imposed on society by the production and consumption of a good or service, and taxes are a politically unobtainable corrective, we need the long arm of government to supplement the invisible hand.

Environmental costs are the most often cited as a justification for regulation. So when the government mandated the cleaning of our air, and set pollution limits, good policy did not require opposition to the proposed regulatory regime. Instead, sensible policy was designed to make certain that the regulations could be complied with in the most efficient possible way-in that case by allowing pollution permits to be traded so that the lowest-cost solutions would be the first adopted.

Now the issue is climate change, which may or may not be a problem, and may or may not be caused by human activity. On the chance that it is, economists would prefer to tax pollutants, so that those responsible pay a price, and that a higher, tax-inclusive price would discourage creation of still more emissions. But that is not to be, at least until Congress realizes the damage mounting deficits might do to the economy, and the need of the military and our infrastructure for increased spending.

In that context, we have two choices. Permit pollution to continue to increase, or devise efficient regulatory responses to address the risk-certainty is not possible-that allowing the problem to go unaddressed might produce unpleasant and irreversible consequences.

Unfortunately, in the hands of President Obama, no invitation to regulate could be ignored. And given the progressive proclivity when it comes to expanding the reach of government, it is no surprise that mere lip service, if that, was paid to a comparison of the costs and benefits of the rules and regulations that bloated the Federal Register and imposed costs on companies-no, not on companies, but on consumers, since similarly-afflicted companies do not have to fear being at a competitive disadvantage by raising prices or reducing the quality of their offerings.

The needed counter-attack, led by President Trump and his appointees, is now in full swing. But something about babies and bathwater comes to mind. Start with the EPA, an agency so certain of its regulatory actions that its then-administrator, Gina McCarthy, once calmly told a congressional committee that she would not share the data on which her agency’s regulations were based. Not even with the elected representatives charged with reviewing those rules. And that she enacted rules that might have little effect on climate but show “strong domestic action which can actually trigger global action to address what is necessary action.” A benefit so expansive and unmeasurable that in the hands of a devoted regulator it would justify any cost-if the regulator cared to consider cost at all.

So when Trump appointed Scott Pruitt to reverse EPA’s regulatory overreach, conservatives had reason to cheer. Here was a man who knew the energy business, who had jousted with the EPA in court, and who would take on the entrenched bureaucracy even though it meant constructing a $25,000 soundproof communication booth in his office to shield him from hostile eavesdroppers among the entrenched holdovers on his staff. The hostility of his staff is a tribute to Pruitt’s effectiveness. For which two cheers.

But the third should be withheld because Pruitt is as mindless a deregulator as his successors were regulators. Not for him cost-benefit analysis to separate regulatory chaff from the wheat. Or the thought that, properly crafted, regulation can offset a failure of prices to account for the probability that the climate-change advocates might, only might, be right.

It’s a good idea to dismiss members of advisory panels who benefit from EPA grants: they are hardly likely ever to slap the hand that feeds them. It’s not such a good idea to replace them with industry advocates rather than well-credentialed, disinterested experts. Good idea to review how research funds are allocated. Not such a good idea to bar EPA staff from presenting papers at scientific seminars. In short, for so long as some markets, left unregulated, create social costs that can be reduced by efficient regulation, such regulation is in order. Deregulation for its own sake is a no more sensible policy goal than regulation for its sake.

As for banking, there is little doubt that in the heat of the financial collapse, regulations such as Dodd-Frank and its offspring were overly intrusive, making lending more costly and less attractive than it had to be. Nor is there any doubt that, like all devoted regulators, those at the Fed and other agencies sought to expand their reach, for example including in their net not only firms that create a systemic threat, but some that clearly do not, such as regional banks and insurance companies. But there is also no doubt that large banks in this increasingly concentrated industry do create a danger to the financial system, and that the harm they can create ripples out far beyond their own shareholders (an externality, in the jargon of the economist’s trade). They remain too big to fail, making regulation necessary to minimize the risk of failure.

Consequently, ill-considered wholesale repeal of the crisis-induced financial regulations might well be more dangerous to the stability of the financial system than the excesses of the regulatory regime created during the Obama years. Which is why Randal Quarles, a Trump addition to the Fed board of governors as vice chairman for supervision, has it right if he means it when he says, “While I am advocating a simplification of large-bank loss-absorbency requirements, I am not advocating enervation of the regulatory capital regime.” Less complex banks and regional banks will face “meaningfully less strict” regulation, and such tools as stress tests will be made more transparent. A scalpel, not an axe. And a lesson for Mr. Pruitt. And those who would relax regulations on the financial sector to the extent of leaving in charge, unregulated, those who assured us it was safe to bundle together mortgages of high-risk borrowers into a security that was worthy of an AAA rating.

We are clearly at a necessary policy turning point, where a presumption that regulation is necessary is being replaced by a presumption that it is not. Fine. But presumptions are merely a background for study-study aimed at devising efficient protections of consumers, the overall economy, and the environment. Barack Obama was wrong when he said that in the case of climate change “the science is settled.” It never is, as Galileo tried to point out. And economists who believe they fully understand the interrelations of the institutions that make up the financial sector might do well to re-read the case of Lehman Brothers, a not-very-big firm with a very big, and surprising, impact on its larger brethren. The last thing we need as we shrink the regulatory state is to replace progressives’ regulatory hubris with the unthinking hubris of the new deregulators.

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