The Obfuscation Report

The 30-year era of deregulation came to a sudden and surprising end on Sept. 16.

Late that evening the Federal Reserve extended $85 billion to take an unprecedented 80 percent stake in American International Group in order to save the floundering insurance giant. Less than two weeks earlier, Treasury Secretary Henry M. Paulson Jr. had announced that the federal government was taking over Fannie Mae and Freddie Mac, the colossal mortgage agencies. Suddenly the U.S. financial sector could not survive without government help.

Since the long-ago days when Jimmy Carter was President, regulation has been a dirty word in Washington. Politicians of both parties vied to see how much of the economy they could free from the oppressive yoke of government control. The deregulation movement started when Carter signed the Airline Deregulation Act of 1978. Later, as it spread from energy to trucking to telecommunications to financial services, the rallying cry was the same: Less regulation, more growth.

But the implosion in financial services — until recently seen as the shining example of U.S-style free market capitalism — is the definitive sign that deregulation has lost its allure. In areas ranging from food safety to airlines to trade, increased government supervision is becoming acceptable to business as well as to voters.

"Over the past couple of years, the mood has changed," says Chris Waldrop, director of the Food Policy Institute at Consumer Federation of America. "What's possible has expanded."

Indeed, both consumer and industry groups have come out in favor of giving the Food & Drug Administration stronger authority to monitor food safety. The shift toward reregulation is reflected in the Presidential campaigns. Back in March, Senator John McCain (R-Ariz.) said: "I'm always for less regulation" and referred to himself as "fundamentally, a deregulator." But in a Sept. 16 speech the Republican nominee adopted a far different approach: "Under my reforms, the American people will be protected by comprehensive regulations."

On the same day, the Democratic nominee, Senator Barack Obama, (D-Ill.) who has argued much more aggressively about the need to bolster regulation, stepped up his rhetoric as well: "It's time to get serious about regulatory oversight," he said.

The implication: "We're moving in the direction of more regulation," says Tom Gallagher, who analyzes Washington policy at International Strategy & Investment. "The direction is locked into place; the only question now is magnitude."

That's a big change. Over the past three decades, the U.S. economy has more than doubled in size, and the private workforce has grown by 70 percent. Yet overall, outside the Defense Department, the executive branch employs about the same number of people today as it did in 1978.

What's more, many regulatory agencies in Washington have even shrunk. Since 1977 the budget of the Environmental Protection Agency has fallen by nearly 40 percent in real terms. Financial industry regulation hasn't kept up, either. Despite the vastly increased complexity of the financial sector, the number of employees working at the Federal Reserve, including the regional Fed banks, has decreased since 1990.

Advocates of deregulation in both parties argued persuasively that this decline in the role of government was essential for U.S. competitiveness. The classic case, of course, was financial sector deregulation. Alan Greenspan, as Fed chairman, supported "counterparty supervision," which meant financial institutions would keep close watch on their trading partners out of self-interest. And Robert E. Rubin, as Treasury Secretary under President Bill Clinton, helped repeal the Glass-Steagall Act, which had restricted what commercial and investment banks could do. Moreover, deregulation, in general, was good politics.

Voters generally don't like regulations, says Larry M. Bartels, director of the Center for the Study of Democratic Politics at Princeton University. "The notable exception to that is when people are scared."

Certainly, there have been plenty of scares in the past few years. A series of food poisoning episodes — notably, the salmonella outbreak that sickened about 1,500 people earlier this year — made consumers worry about the safety of the nation's food supply. What's more, it became clear that the Food & Drug Administration had no easy way to trace tainted food back to its source.

Those incidents resulted in a major turnabout in the food industry's view of regulation. It once loved the fact that the FDA didn't have the money or inspectors to scrutinize it. "The reduction in regulation has made things worse, and industry recognizes it," says William K. Hubbard, a former FDA associate commissioner. "I think they really became aware of their vulnerability."

Electric utility deregulation, too, is coming under increasing attack because true competition has been slow in coming. "I don't think there's any question the pendulum is swinging away from deregulation," says Charles D. Gray, executive director of the National Association of Regulatory Utility Commissioners.

One example: The Federal Energy Regulatory Commission was recently granted the authority to mandate the construction of transmission lines. "A lot of the infrastructure issues are not well suited to competition or market opening," says Gray.

The breakdown of the financial markets has left open the question of how much deregulation will be left when the dust settles. "Everyone thought the market had it under control," says economist and financial industry expert Robert E. Litan, vice-president for research and policy at the Ewing Marion Kauffman Foundation Institution. "It was believed by a lot people, even including me."

Not everyone agrees the era of deregulation is over. In energy, voters seem willing to support more offshore drilling. And Daniel Clifton, head of the Washington office of Strategas Research Partners, argues that state and local governments will still have to privatize roads, prisons, and other pieces of their infrastructure. Increasing government control will never be as sexy and politically potent as deregulation once was. But at least for now, reregulation looks like the wave of the future.

# posted by The Punisher @ Friday, September 19, 2008