The Politics of Financial Regulation and the Regulation of Financial Politics
Adam J. Levitin
Georgetown University Law Center
March 21, 2014
Harvard Law Review, Vol. 127, 2014
This review essay considers six recent books on the financial crisis (Bernanke, Blinder, Bair, Barofsky, Connaughton, and Admati & Hellwig). The essay discerns two basic narratives of the crisis in these books and in the regulatory response to the crisis: the perfect storm narrative and the regulatory capture narrative. The perfect storm narrative is a story of dynamic financial markets outpacing static regulation, which was then overwhelmed by a perfect storm. In this narrative, no one was at fault for 2008, and financial regulators were the heroes who saved the economy. The regulatory capture narrative, in contrast, is a story of a completely preventable crisis that was enabled by feckless regulators who deserve faint praise for putting out the fire they started.
Most of the policy response to the crisis responds to the problems perceived by the perfect storm narrative. Yet, it is hard not to credit the regulatory capture narrative to at least some degree, and most of the books reviewed acknowledge a capture problem. Some post-crisis reforms are in fact responsive to perceived capture problems: the elimination of the Office of Thrift Supervision, the change in federal preemption standards, the creation of the Consumer Financial Protection Bureau, and the Durbin Interchange Amendment. These responses, however, represent very different approaches to capture. The CFPB is a doubling down on agency independence, while the Durbin Interchange Amendment represents an embrace of political contestation of policy that carries on the Glass-Steagal Act's tradition of divide-and-conquer on industrial organization lines.
The essay argues that the lesson from the books reviewed is that we are simply having the wrong debate about financial regulation. The real issue in financial regulation is politics, not technical regulatory questions. A focus on the technical details of regulation without addressing the politics of financial regulation will result in unsustainable regulatory reforms. Only by reforming the politics of financial regulation will we achieve lasting financial regulation that achieves the socially optimal balance of stability and growth.
To this end, the essay explores the range of approaches to dealing with financial politics illustrated in the Dodd-Frank Act and suggests that rather than doubling down on agency independence, we might do better by trying to harnessing rent-seeking impulses through industrial organization in order to neutralize political influence on the regulatory process.
Number of Pages in PDF File: 75
Keywords: financial crisis, bailout, Federal Reserve, cramdown, capture, CFPB, Durbin, interchange, money market mutual funds, NAV
JEL Classification: G21, G28, K23
Date posted: March 3, 2014 ; Last revised: March 21, 2014
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