Time (Yet Again) for Preventative Regulation

First, look at the nation’s history: The Bush administration, Ben Bernanke of the Federal Reserve and the financial sector all think the actions they’ve taken in recent days and weeks will fend off disaster. That’s unlikely. Today’s crisis calls for a new take on what used to exist: preventative regulation. So how to get there?

The recent salvage of the investment bank Bear Stearns is in fact the legacy of decades of anti-regulation ideology. After the Fed allowed Drexel Burnham Lambert, Michael Milken’s junk bond shop, to die a slow death from 1986 to 1990, the term “regulation” virtually disappeared from the political landscape and lexicon. This trend has left ever more complex financial markets and multinationals to operate in barely regulated risky gray areas.

The latest near collapse of one of Wall Street’s biggest firms recalls the market intervention and regulatory debates of a century ago. In 1907, President Theodore Roosevelt authorized the Treasury to work with J.P. Morgan to build a support package for several nearly insolvent trust companies. This effort quelled market panic and made Morgan a small fortune in the process.

But this was part of a larger battle over regulation. In contrast with the Fed’s current bailout, in 1907 the financial community argued that market failures were the product of the president’s overzealous regulating and antitrust prosecutions. These policies, they said, made borrowing and operating costs far higher for most holding companies.

But others in the reform movement and the legal community saw large corporate trusts as incompatible with social and economic progress. They explained the panic of ’07 as a failure to regulate financial speculation and to expose the concealed interlocking management of trusts, banks and brokerage houses. All of which, they argued, was worsened by the absence of a strong central bank.

The presidential election of 1912 marked a climax for a developing philosophy of regulating financial markets and businesses. As in 2008, that election pivoted on the issue of “change,” but it was characterized by three potent visions of active governance: Socialist Eugene Debs argued for the nationalization of industry in the interest of labor. Roosevelt pushed for increased corporate regulation and sweeping progressive and welfare reforms. Woodrow Wilson largely agreed with Roosevelt but went further in seeking more stringent measures in trust-busting and banking reorganization.

After he became president, Wilson helped establish the Federal Reserve and in 1914 signed the Clayton Act. This legislation extended the Sherman Antitrust Act of 1890, which had created the Federal Trade Commission to prohibit price discrimination and evaluate the monopolistic implications of specific mergers and acquisitions.

The next shift was one of both degree and kind: the New Deal. With the country in the grip of the Great Depression, Franklin Roosevelt saw the merits of vigorous intervention. He combined sweeping regulation to control the economy and manage currency with specific reforms to distribute power away from big business and toward the worker and consumer. One such remedy with present-day relevance was the Glass-Steagall Act. Passed in 1935, extended in the 1950s, but repealed in 1999, the act created an oversight regime and a firewall between investment and commercial banking activities.

While implementation was imperfect and stifled some financial innovation, the loss of the Glass-Steagall regulatory framework contributed to recent unsound lending practices and risks taken by banks like Bear Stearns. To prevent such dangers again in the future we should reestablish the barrier between the investment and commercial banking. Delayed and inadequate regulation exposes the public to unacceptable risks.

Glass-Steagall’s demise reveals the hazards of antiregulatory trends since the 1970s, marked by President Carter’s deregulation of various industries and by Reagan’s high-profile firing of striking air traffic controllers. Today there remains a widespread sense that active government regulation fails to serve the public interest. This belief also feeds a faith in laissez faire self-regulation. As a result, lax enforcement and a lack of regulation have exacerbated the sub-prime mortgage and banking crises and led to the tardiness of discovery of tainted children’s toys and meat products.

Our central historical challenge is as important today as it has ever been. The moral hazards of less regulation now outstrip the costs of greater intervention.

There really isn’t a need for more regulation. What are missing are better supervision and a public regulatory vision to guide it. The best regulatory policies proceed on a case-by-case basis, with the right talent to oversee each sector. The regulatory path forward should not be more, but better, oversight to backstop the market, to protect citizens, to train and fund supervision of complicated financial tools and markets and to catch and penalize those people and institutions acting irresponsibly.

America has a long history of dynamic, constructive regulation. As in 1912, the politics of “change” is in the air. Today’s regulators are bailing out Bear, a firm that was its own worst enemy, to keep markets operating and to bolster investor confidence. Still, anti-regulatory ideology and corporate excesses run deep. To overturn them will require political change built around the central philosophy of 1912: tough preventative oversight, when risk-takers are making outsized profits.

Christopher McKnight Nichols is the Andrew W. Mellon Postdoctoral Fellow in U.S. History at the University of Pennsylvania. He is author of Promise and Peril: America at the Dawn of a Global Age (Harvard University Press, 2011), co-editor and co-author of Prophesies of Godlessness: Predictions of America's Imminent Secularization from the Puritans to the Present Day (Oxford University Press, 2008), and Senior Editor of the forthcoming Oxford Encyclopedia of American Military and Diplomatic History.

March, 2008