The term “regulatory capture” refers to what happens when regulators swim so close to the companies they regulate that they get snared in those companies’ gravitational fields. What results is tolerant, indulgent regulation, or none at all. For a good example, think of banking regulation before 2008. The result of regulators seeing things the banks’ way: the 2008 financial crisis and a long, deep recession.
Regulatory capture has come up in public discussions three times in recent days: a top banking industry lawyer says it’s a “myth”; a top banking regulator says there’s still too much of it; and a top securities regulator may have inadvertently provided a great example of it.
To take these in order: On Wednesday, the veteran banking attorney H. Rodgin Cohen fired a broadside at the federal government’s Wall Street regulators, calling “the regulatory environment today ... the most tension-filled, confrontational and skeptical of any time in my professional career,” in remarks at a banking conference in Phoenix quoted by the Wall Street Journal. Since Cohen’s legal career spans nearly half a century, that’s saying a lot.
Taking aim at “the myth of regulatory capture,” he continued: “Recently, this supposition of regulatory capture has become as pervasive as it is false.... I have never experienced a situation that an examiner was so close to an institution that the examiner went easy on that institution.” Sharing the dais with him at the time were representatives of the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Reserve Bank of New York and the industry self-regulator Finra, the Journal reported.
Cohen’s concern is that regulators desperate to disprove the “myth” will be especially, and unreasonably, hard on the banks, which will only make regulation less effective and, of course, make it harder for banks to do business.
As it happens, Cohen’s plaint followed by only a couple of weeks a statement by Federal Reserve Chair Janet L. Yellen implying that banking regulators still aren’t tough enough. In a March 3 speech in New York, she mentioned the risks of regulatory capture as including “tangible conflicts of interest -- for example, the expectation government officials might have of future rewards from the industry they oversee,” as well as conflicts that arise "when close contact and familiarity between individuals leads those enforcing the rules to sympathize with those they oversee.”
Yellen said the Fed is constantly on its guard against regulatory capture. She also attributed the financial crisis to breakdowns in regulation, some of which plainly fell into the category of “capture,” including “the expansion of a largely unregulated ‘shadow banking system’ rivaling the traditional banking sector in size and the failure of “checks and balances that were widely expected to prevent excessive risk-taking by large financial firms -- regulatory oversight and market discipline.”
As for “close contact and familiarity” between individuals and their regulated businesses, one need look no further than a March 5 appearance at a Stanford conference by Andrew Bowden, the SEC’s director of examinations. Financial blogger Yves Smith of Naked Capitalism, a former investment banker and management consultant, writes that Bowden “reveals himself to be captured to an embarrassing degree. His remarks about the industry aren’t merely fawning.... Bowden comes uncomfortably close to the line of offering to play the revolving door game at an unheard-of level of crassness, putting his son, and by implication himself, into the job market at an industry conference.”
Those are harsh words, but justified. Bowden called the asset management business -- which falls within the SEC’s jurisdiction -- “the greatest business you could possibly be in. You’re helping your clients.” He continued on the subject of the private equity business, “where we have seen some misconduct and things like that, ’cause I always think like, to my simple mind, that the people in private equity, they’re the greatest, they’re actually adding value to their clients, they’re getting paid really really well, you know, if I was in that position, the one thing I would think to myself as I skipped to work was like just ‘Let’s not mess it up. You know, this is the greatest thing there, I’m helping people, I’m doing OK myself.’”
Then he said: “I tell my son, I have a teenaged son, I tell him, ‘Cole, you want to be in private equity. That’s where to go, that’s a great business, that’s a really good business. That’ll be good for you.”
At that point a questioner interrupted to say: “I’d love to hire your son, by the way. That’s a deal.”
See Smith’s post here for a video of the remarks. At the minimum, they’re "cringe-making coming from a regulator,” Smith says.
Former regulator William K. Black, who brought many wrongdoers in the savings-and-loan scandal to account, wrote that he “would have asked for the resignation of any of my staff who made remarks even remotely like Bowden’s remarks. As financial regulators, particularly if we have the disadvantage of coming from the industry, we maintain at all times a professional distance from those we regulate. The remarks about his son are so beyond the pale that they demonstrate he is incapable of even pretending to maintain such a professional distance.”
What makes this display especially distressing is that Bowden, in public remarks last year, was openly and frankly critical about this same private equity industry, detailing some of the lawbreaking his staff had unearthed. The Stanford conference was a less public event -- indeed, Stanford tried to take down the video of the event after it started making the rounds -- which raises the question of which Andrew Bowden is the one on the job. (Stanford says the event was free and open to the public; the video was taken down only temporarily to edit out extraneous footage of the room before the panel discussion began. Stanford’s video is here.)
Despite the words of Cohen and Bowden, the financial industry still enjoys too little regulation, not too much. Yellen, asked at a news conference Wednesday if the compliance “culture at the banks is where it ought to be,” replied in the negative. “It’s certainly been very disappointing to see what have been some really brazen violations of the law,” she said.
As we’ve written in the past, bankers and other business leaders always complain about being over-regulated, and always paint the darkest picture of its effect on commerce and the fate of the republic.
Auto executives made the same complaints in the 1970s about mandates for shoulder harnesses and air bags. In the 1930s, New York Stock Exchange boss Richard Whitney warned that the creation of the SEC would bring about "massive and intrusive new government bureaucracies” that would drive stock prices into the basement.” (This was a few years before Whitney went to jail for fraud.)
What they didn’t realize is that strict regulation of their industries set the groundwork for greater growth. Automakers learned soon enough that safety was a feature that buyers actually would pay for. Wall Street learned that strict regulation and transparent business dealings were the only path to recovering the confidence of the investing public.
Underlying today’s anti-regulation rhetoric may be the same realization. Bankers would have to be blind not to see it. The financial reports of JPMorgan Chase & Co. show that the huge bank has paid out some $19 billion since 2012 on litigation costs, including to settle allegations of wrongdoing; in its latest annual report, the list of cases runs to seven pages. JPMorgan has withdrawn from or cut back some of the businesses in which it ran into trouble; perhaps tighter regulatory scrutiny would have saved the bank money in the long run.