Planet Money: Avoiding Government Oversight

Regulators often get bested by the powerful vested interests they oversee. It doesn't matter whether it's oil, mining or banking. Companies figure out ways to avoid government oversight. There's even a name for it — "regulatory capture."

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House and Senate leaders are finalizing details on a financial reform bill this week. There are still a few sticky issues, but one thing's for sure, the legislation would create one new regulator called the Consumer Financial Protection Bureau. And it would kill another, the Office of Thrift Supervision, or OTS. That's the regulator for savings and loans.

Chana Joffe-Walt with our Planet Money team reports that for regulators at the OTS, this kind of change is nothing new.

CHANA JOFFE-WALT: Lawrence Kaplan used to work for the OTS. He also used to work for a banking regulator you've probably never heard of because it is now dead.

Mr. LAWRENCE KAPLAN (Former Regulator, Office of Thrift Supervision): I worked for the Federal Home Loan Bank Board, which was the federal regulator of savings and loan associations.

JOFFE-WALT: In the late 1980s, savings and loans were failing left and right, and the Federal Home Loan Bank Board was the savings and loan regulator, which meant Kaplan and his colleagues were getting noticed.

Mr. KAPLAN: When I went to work there nobody ever heard of it and suddenly it's on the news, so all of a sudden you could say, that that's us.

JOFFE-WALT: 1989, a new administration comes in. And responding to public outcry, Congress begins to write legislation to reform the financial regulatory system. This should all sound familiar. And in 1989, President Bush, the first one, signs new legislation, banking reform. He walks out into the Rose Garden to make a speech and Lawrence Kaplan is watching it happen on TV. He remembers the moment well.

Mr. KAPLAN: We, a group of lawyers, went to the rooftop of the Hotel Washington. We watched the Rose Garden ceremony, got rid of this agency that caused the problem.

JAFFE-WALT: Got rid of you guys.

Mr. KAPLAN: He got rid of the Federal Home Loan Bank Board. What happened is, we walked back and it was amazing because they changed the name on the building already. It said the Office of Thrift Supervision. We went up, actually, on our chairs, there was a memo saying, you know, congratulations, we're now the Office of Thrift Supervision. They didn't get rid of the agency on the org chart, they just renamed it.

JAFFE-WALT: And the regulators went back to work. Sure, there were new rules, new leadership, but the people stayed the same. Except Kaplan, he moved on to work in the private sector. And to be clear, Kaplan says he and his colleagues did not mess up. Regulators could only enforce the rules as they were written. And in the early 1980s, Congress changed the rules on them. Thrifts were allowed to take too many risks, so Kaplan says the regulators' hands were tied.

But here is what happened next. The renamed agency, the OTS, later became regulator of Washington Mutual, AIG and Countrywide, all key players in our current financial crisis. And so, Congress is now sitting down to rewrite banking reform. Here's Lawrence Kaplan again.

Mr. KAPLAN: What's happening now, both the House and the Senate bills propose eliminating the OTS, merging its functions into other agencies so that...

JAFFE-WALT: Just like what happened to you.

Mr. KAPLAN: Basically, 20 years later, history is repeating itself.

Mr. VINCENT REINHART (Economist, American Enterprise Institute): Unfortunately, you know, the biggest problem in regulation is they're enforced by people.

JAFFE-WALT: This is Vincent Reinhart. He's an economist with the American Enterprise Institute. And we talked for a long time about a catchy economic phrase for what is happening here - regulatory capture. The idea is basically that the industry being regulated - in this case it's banks, but it could be oil, mining, whatever - that industry will always work overtime to capture two groups of people, the people writing the rules, Congress and the people enforcing the rules, regulators like the people at the OTS.

And the industry will use lots of capture tactics. They'll use money, time, gifts, they'll help write legislation, they'll help regulators fill out complicated forms. Reinhart says the industry does this all the time and not just during a crisis.

Mr. REINHART: Over time, the government sees its rules aren't being enforced effectively. So it makes its rules more complicated. But if it's more complicated, then the private sector just spends even more resources to figure out ways to get around the rules. And the government makes the rules even more complicated. And at no point have we even gotten to moral failure and greed.

JAFFE-WALT: You know who's really susceptible to moral failure and greed? People. Reinhart says considering it is people who write the rules and people who enforce the rules, that impulse to make regulation more complicated is all wrong.

Mr. REINHART: You take into account that regulations have to be enforced by people and that the more judgment you give those people, the more possibilities of things going wrong. You try to draw very bright lines.

JAFFE-WALT: And then, Reinhart says, you redraw the lines, not just in a crisis, but as often as humanly possible.

Chana Jaffe-Walt, NPR News, New York.

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