Cultural capture and the financial crisis

Preventing Regulatory Capture: Special Interest Influence and How to Limit it

Volumn 9781107036086, Issue , 2013, Pages 71-98

  Kwak, James ^a  

^a NONE

Author keywords

[No Author keywords available]

Indexed keywords

EID: 84892621434     PISSN: None     EISSN: None     Source Type: Book    
DOI: 10.1017/CBO9781139565875.008     Document Type: Chapter

References (128)

1. Associate Professor, University of Connecticut School of Law. I would like to thank Christine Jolls, the other authors represented in this volume, and two anonymous reviewers for helpful suggestions.
2. Smiley, V. Citi bank (South Dakota), N.A., 517 U.S. 735, 738 (1996).
3. Office of the Comptroller of the Currency, “Interpretive Rulings,” 60 Fed. Reg. 11924, 11929 (1995).
4. Section 85 of the National Bank Act, 12 U.S.C. § 85, interpreted by Marquette National Bank of Minneapolis v. First of Omaha Service Corp., 439 U.S. 299 (1978).
5. Citibank located its credit card issuing bank in South Dakota because of favorable regulation offered by that state. Robin Stein, “The Ascendancy of the Credit Card Industry,” Frontline, November 23, 2004.Available at http://www.pbs.org/wgbh/pages/frontline/shows/credit/more/rise.html.
6. Smiley, 517 U.S. at 739.
7. Smiley, 517 U.S. at, 741.
8. Steven P. Croley, “Public Interested Regulation,” Florida State University Law Review 28 (Fall 2000): 75-84
9. Adam J. Levitin, “Hydraulic Regulation: Regulating Credit Markets Upstream,” Yale Journal on Regulation 26 (Summer 2009): 152-5.
10. Simon Kwan, “Cracking the Glass-Steagall Barriers,” Federal Reserve Bank of San Francisco Economic Letter 97-08, March 21, 1997.
11. Binyamin Appelbaum, “Fed Held Back as EvidenceMounted on Subprime Loan Abuses,” Washington Post, September 27, 2009. Available at http://www.washingtonpost.com/wp-dyn/content/article/2009/09/26/AR2009092602706.html.
12. Corine Hegland, “Why It Failed,” National Journal, April 11, 2009, 12-20.
13. Securities and Exchange Commission, “Final Rule: Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities,” 69 Fed. Reg. 34428 (2004).
14. SEC Office of Inspector General, SEC’s Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity Program, September 25, 2008.
15. Binyamin Appelbaum and Ellen Nakashima, “Banking Regulator Played Advocate Over Enforcer,” Washington Post, November 23, 2008. Available at http://www.washingtonpost.com/wp-dyn/content/article/2008/11/22/AR2008112202213.html.
16. Government Accountability Office, OCC Preemption Rulemaking: Opportunities Existed to Enhance the Consultative Efforts and Better Document the Rulemaking Process, October 2005, 30-6.
17. Government Accountability Office, OCC Preemption Rulemaking: Opportunities Existed to Enhance the Consultative Efforts and Better Document the Rulemaking Process, October 2005, 36-40.
18. For the record, Iamhighly skeptical of the “once-in-a-century flood” theory of the financial crisis.
19. Indeed, Romer shows that teams should go for a first down on fourth-and-one regardless of field position, at least early in a game. David Romer, “Do Firms Maximize? Evidence from Professional Football,” Journal of Political Economy 114, no. 2 (April 2006): 352-3.
20. Ronald J.Mann, “Bankruptcy Reformand the ‘Sweat Box’ of Credit CardDebt,” University of Illinois Law Review 375 (2007): 384-92.
21. For example, the argument goes, unlimited late fees allow a bank to compensate itself for the specific risk of late payment; otherwise it would have to compensate itself by increasing the interest rate, which would affect all customers.
22. Public Law 103-325 §§ 152, 156 (1994).
23. Michael M. Phillips and Jessica Holzer, “Regulator Let IndyMac Backdate Infusion,” Wall Street Journal, December 23, 2008. Available at http://online.wsj.com/article/SB122998621544328009.html.
24. In some cases, it is also arguable that deregulatory policies were not the result of the “intent and action” of the financial sector. For example, returning to Smiley, the OCC might have reached its conclusion as a matter of pure statutory interpretation, leaving aside questions of the public interest.
25. For summaries, see Michael E. Levine and Jennifer L. Forrence, “Regulatory Capture, Public Interest, and the Public Agenda: Toward a Synthesis,” Journal of Law, Economics, and Organization 6 (1990): 169-70
26. Steven P. Croley, “Public Interested Regulation,” Florida State University Law Review 28 (Fall 2000): 9-15
27. Nicholas Bagley and Richard L. Revesz, “Centralized Oversight of the Regulatory State,” Columbia Law Review 106 (October 2006): 1284-85.
28. Levine and Forrence, “Regulatory Capture, Public Interest, and the Public Agenda: Toward a Synthesis,” 178.
29. Although this chapter focuses on administrative agencies, the concepts discussed could also apply to other governmental actors.
30. Levine and Forrence, “Regulatory Capture, Public Interest, and the Public Agenda,” 172; Croley, “Public Interested Regulation,” 4.
31. Levine and Forrence, “RegulatoryCapture, Public Interest, and the Public Agenda,” 171-2.
32. Croley, “Public Interested Regulation,” 106.
33. alsoLevine and Forrence, “RegulatoryCapture, Public Interest, and thePublicAgenda,” 185.
34. In a sense, it is also a very old area of inquiry, dating back at least to Alexis de Tocqueville, who attributed America’s “singular paucity of distinguished political characters” to the social pressures to conform to majority opinion. Alexis de Tocqueville, Democracy in America, Translated by Henry Reeve (New York: George Dearborn & Co., 1838), 244-7.
35. Jeffrey J. Rachlinski and Cynthia R. Farina, “Cognitive Psychology and Optimal Government Design,” Cornell Law Review 87 (January 2002): 571-82.
36. Stephen J. Choi and A.C. Pritchard, “Behavioral Economics and the SEC,” Stanford Law Review 56 (October 2003): 20-36.
37. Jon D. Hanson and David G. Yosifon, “The Situation: An Introduction to the Situational Character, Critical Realism, Power Economics, and Deep Capture,” University of Pennsylvania Law Review 152 (November 2003): 14.
38. Hanson and Yosifon’s concept of “deep capture” applies to society in general, not just government actors.
39. WendyWagner, “Administrative Law, Filter Failure, and Information Capture,” Duke Law Journal 59 (April 2010): 1321.
40. Nicholas Bagley. “Agency Hygiene.” Texas Law Review See Also 89 (November 20, 2010): 1-14. Available at http://www.texaslrev.com/seealso/vol/89/responses/bagley
41. A.C. Pritchard, “The SEC at 70: Time for Retirement?” Notre Dame Law Review 80 (March 2005): 1073-1102.
42. For example, Pritchard wrote (2005, p. 1089), “the financial services industry has considerable influence over the information that the SEC receives as it undertakes its rulemaking responsibilities. The result has been a system of securities regulation that largely benefits the big players in the securities industry.”
43. Steven M. Davidoff. “The Government’s Elite and Regulatory Capture.” DealBook, New York Times, June 11, 2010. Available at http://dealbook.nytimes.com/2010/06/11/the-governments-elite-and-regulatory-capture. See p. 39.
44. Jo Becker and Gretchen Morgenson, “Geithner, Member and Overseer of Finance Club,” New York Times, April 26, 2009. Available at http://www.nytimes.com/2009/04/27/business/27geithner.html.
45. Carol A.Needham. “Listening to Cassandra: The Difficult of Recognizing Risks and Taking Action.” Fordham Law Review 78 (April 2010): 2347-2355.
46. Willem Buiter. “CentralBanks and FinancialCrises.” InMaintaining Stability in a Changing Financial System(proceedings of the Federal Reserve Bank of Kansas City Economic Policy Symposium, Jackson Hole, WY, August 21-23, 2008), 601.
47. Adair Turner, interview with Financial Crisis Inquiry Commission Staff, November 30, 2010. Audiotape available at http://fcic.law.stanford.edu/interviews/view/102.
48. Lawrence G. Baxter. “Capture in Financial Regulation: Can We Redirect It Toward the Common Good?” Cornell Journal of Law and Public Policy 21, no. 1 (Fall 2011): 175- 200.
49. In Baxter’s view, “the language of regulation is shaped by the common backgrounds, education, experience and intermingling of the more powerful players in the policy formation process.”
50. Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (New York: Pantheon, 2010), 104-5.
51. In Rachlinski and Farina, “Cognitive Psychology and Optimal Government Design.” 593- 606, for example, Rachlinski and Farina argued that governmental decision-making processes should be informed by what we know about cognitive biases.
52. Yan Chen and Sherry Xin Li, “Group Identity and Social Preferences,” American Economic Review 99 (March 2009): 431-57.
53. Shaun P. Hargreaves Heap and Daniel John Zizzo, “The Value of Groups,” American Economic Review 99 (March 2009): 295-323.
54. These group effects are also correlated with the salience of group membership to participants. See Gary Charness, Luca Rigotti, and Aldo Rustichini, “Individual Behavior and Group Membership,” American Economic Review 97 (September 2007): 1340-52.
55. Randomassignment to groups is valuable because it isolates the effect of groupmembership from the effects of other characteristics that members of a group may share.
56. Lorenz Goette, David Huffman, and Stephan Meier, “The Impact ofGroupMembership on Cooperation and Norm Enforcement: Evidence Using Random Assignment to Real Social Groups,” American Economic Review 96 (May 2006): 212-16.
57. Donors are more likely to find a charity worthy if it is represented as serving people of the donor’s race
58. Christina M. Fong and Erzo F.P. Luttmer, “Do Fairness and Race Matter in Generosity? Evidence from a Nationally Representative Charity Experiment,” Journal of Public Economics 95, no. 5-6 (June 2011): 372-94.
59. George A. Akerlof and Rachel E. Kranton, “Economics and Identity,” Quarterly Journal of Economics 115 (August 2000): 719.
60. George A. Akerlof and Rechel E. Kranton, Identity Economics: How Our Identities Shape Our Work, Wages andWell-Being (Princeton: Princeton University Press, 2010).
61. Akerlof and Kranton, “Economics and Identity,” 719-20.
62. Akerlof and Kranton, “Economics and Identity,” 731 n. 30.
63. Margaret Shih, Todd L. Pittinsky, and Nalini Ambady, “Stereotype Susceptibility: Identity Salience and Shifts in Quantitative Performance,” Psychological Science 10 (January 1999): 80-3.
64. Eric Lichtblau, “Ex-Regulators Get Set to Lobby onNew Financial Rules,” New York Times, July 27, 2010. Available at http://www.nytimes.com/2010/07/28/business/28lobby.html.
65. For large financial institutions, the primary regulator typically locates a group of agency employees on site-hence the identification with the institution itself and not with the outsiders fromWashington.
66. For example, discussing Eliot Spitzer’s prominence in investigating financial industry scandals, Jonathan Macey wrote, “The SEC was fully acclimated to existing market practices and saw no urgent need to change them. The SEC staff identified with the market participants they were ostensibly regulating.” Jonathan R. Macey, “State-Federal Relations Post-Eliot Spitzer,” Brooklyn Law Review 70 (2004): 128.
67. See Croley, “Public Interested Regulation,” 55-66.
68. For a summary and rebuttal of this criticism, see Bagley andRevesz, “Centralized Oversight of the Regulatory State,” 1285-90.
69. Rachlinski and Farina, “Cognitive Psychology and Optimal Government Design,” 579- 80.
70. Bagley and Revesz (p. 1301), however, argued that agency bureaucrats are motivated less by ideology and more by “career advancement, producing a quality work product, and abiding by professional and ethical norms.”
71. Catherine C. Eckel, Enrique Fatas, and Rick Wilson, “Cooperation and Status in Organizations,” Journal of Public Economic Theory 12, no. 4 (2010): 740
72. Cecilia L. Ridgeway and Kristan Glasgow Erickson, “Creating and Spreading Status Beliefs,” American Journal of Sociology 106 (November 2000): 580.
73. Sheryl Ball and Catherine C. Eckel, “The Economic Value of Status,” Journal of Socio- Economics 27, no. 4 (1998): 503-7. Participants thought that status was assigned based on the quiz, but the actual assignment was effectively random. It is theoretically possible that participants believed that people who are good at trivia quizzes either deserve more money or are more likely to reject low offers, but this would only demonstrate the tendency of status distinctions in one realm to affect behavior in generally unrelated realms.
74. Ball andEckel, “TheEconomicValue of Status,” 507-10
75. Sheryl Ball, Catherine Eckel, Philip J. Grossman, and William Zame, “Status in Markets,” Quarterly Journal of Economics 116 (February 2001): 161-88.
76. Edward L. Glaeser, David I. Laibson, Jos´e A. Scheinkman, and Christine L. Soutter, “Measuring Trust,” Quarterly Journal of Economics 115 (August 2000): 836-40.
77. Edward Robinson, “Winning Super Bowl Lets Montana Teammates Fumble Elite Investing,” Bloomberg Markets Magazine, February 9, 2011. Available at http://www.bloomberg.com/news/2011-02-02/winning-super-bowls-lets-montana-teammates-fumblehandling- elite-investor.html.
78. Joseph Henrich and Francisco J. Gil-White, “The Evolution of Prestige: Freely Conferred Deference as a Mechanism for Enhancing the Benefits of Cultural Transmission,” Evolution and Human Behavior 22 (2001): 184-6.
79. Joseph Henrich and Francisco J., Gil-White, “The Evolution of Prestige: Freely Conferred Deference as a Mechanism for Enhancing the Benefits of Cultural Transmission,” Evolution and Human Behavior 22 (2001): 184.
80. Joseph Henrich and Francisco J., Gil-White, “The Evolution of Prestige: Freely Conferred Deference as a Mechanism for Enhancing the Benefits of Cultural Transmission,” Evolution and Human Behavior 22 (2001): 185.
81. Cagri S. Kumru and Lise Vesterlund, “The Effect of Status on Charitable Giving,” Journal of Public Economic Theory 12 (August 2010): 709-35.
82. Cagri S. Kumru and Lise Vesterlund, “The Effect of Status on Charitable Giving,” Journal of Public Economic Theory 12 (August 2010): 709-35.
83. Eckel, Fatas, andWilson, “Cooperation and Status in Organizations,” who found that participants in a voluntary contribution game are more likely to imitate a high-status player and are more responsive to punishment by a high-status player.
84. Catherine C. Eckel and Rick K. Wilson, “Social Learning in Coordination Games: Does Status Matter?” Experimental Economics 10 (2007): 317-29.
85. Akerlof and Kranton, “Economics and Identity,” 719.
86. Gary Charness, David Masclet, and Marie-Claire Villeval, “Competitive Preferences and Status as an Incentive: Experimental Evidence,”Working Paper 1016, Group d’Analyse et de Théorie É conomique Lyon-St. É tienne, June 2010.
87. Bernardo A. Huberman, Christoph H. Loch, and Ayse Ö nculer, “Status as a Valued Resource,” Social Psychology Quarterly 67 (2004): 103-14.
88. Jerry Suls, Reńe Martin, and Ladd Wheeler, “Social Comparison: Why, With Whom, and With What Effect?” Current Directions in Psychological Science 11 (October 2002): 159- 63.
89. Roy F. Baumeister, “A Self-Presentational View of Social Phenomena,” Psychological Bulletin 91, no. 1 (1982): 3.
90. Pierre Bourdieu, Distinction: A Social Critique of the Judgment of Taste, Translated by Richard Nice (Cambridge, MA: Harvard University Press, 1984), 6.
91. “Slate 60: Donor Bios,” Slate, February 5, 2010. Steven Schwarzman, founder of Blackstone, has contributed $100 million to the New York Public Library (whose main building is named after him) and is chair of the board of the John F. Kennedy Center for the Performing Arts. “Slate 60: Donor Bios,” Slate, January 23, 2009.
92. Cailey Hall, “Wall Street: Paradise Found?” Daily Princetonian, September 29, 2005. Available at http://www.dailyprincetonian.com/2005/09/29/13254/.
93. Karen Ho, Liquidated: An Ethnography ofWall Street (Durham, NC:DukeUniversity Press, 2009), 42-55.
94. These were rules mandated by the Basel I Accord for calculating capital requirements.
95. Steve Randy Waldman, “Sympathy for the Treasury,” Interfluidity, November 5, 2009. Available at http://www.interfluidity.com/posts/1257407150.shtml.
96. Cookies are no joking matter. In December 2010, as the Federal Communications Commission was setting rules for managing Internet traffic, AT&T sent the agency 1,530 cupcakes from Georgetown Cupcake. Edward Wyatt, “Arsenal of a Lobbyist: Hardball and Cupcakes,” New York Times, March 26, 2011. Available at http://www.nytimes.com/2011/03/27/business/27phone.html.
97. Baumeister, “A Self-Presentational View of Social Phenomena,” 3.
98. Baumeister, “A Self-Presentational View of Social Phenomena,” 8.
99. Steven Tadelis, “The Power of Shame and the Rationality of Trust,” Working Paper, March 2, 2011.
100. Tadelis, “The Power of Shame and the Rationality of Trust,” 14-15.
101. Charness, Rigotti, and Rustichini, “Individual Behavior and Group Membership.” 93 AlexandreMas and EnricoMoretti, “Peers atWork,” American Economic Review99 (March 2009): 112-45.
102. Glaeser et al., “Measuring Trust,” 834-86.
103. Errol Meidinger, “Regulatory Culture: A Theoretical Outline,” Law & Policy 9 (October 1987): 365.
104. Ian Ayres and John Braithwaite, “Tripartism: Regulatory Capture and Empowerment,” Law & Social Inquiry 16 (Summer 1991): 471.
105. Similarly, daily contact with agency staff can influence the positions held by agency heads, as described by Livermore and Revesz in this volume (see Chapter 15), reducing the potential impact of new political appointees on agency policies.
106. One potential consequence, according to Baxter, is “a cognitive bias in which different views are not even perceived, let alone recognized and properly analyzed.” Baxter, “Capture in Financial Regulation.”
107. George J. Stigler, “The Theory of Economic Regulation,” Bell Journal of Economics and Management Science 2 (Spring 1971): 10-13
108. Croley, “Public Interested Regulation,” 13-15.
109. Croley, “Public Interested Regulation,” 18-21.
110. This is an example of how “[t]he financial crisis and the national debate over financial regulation opened a social aperture in the realm of finance policy making.” Daniel Carpenter, “The Contest of Lobbies and Disciplines: Financial Politics and Regulatory Reform in the Obama Administration,” in Lawrence Jacobs and Theda Skocpol, eds., Reaching for a New Deal: President Obama’s Agenda and the Dynamics of U.S. Politics (Russell Sage Foundation, 2011).
111. Ben Protess and MacWilliam Bishop, “At Center of Derivatives Debate, a Gung-Ho Regulator,” DealBook, The New York Times, February 10, 2011. Available at http://dealbook.nytimes.com/2011/02/10/at-center-of-debate-over-derivatives-a-gung-ho-regulator/.
112. Or, at least, like most well-educated Americans. See Joseph Henrich, Steven J. Heine, and Ara Norenzayan, “The Weirdest People in the World?” Behavioral and Brain Sciences 33 (2010): 61-135.
113. Rachlinski and Farina (“Cognitive Psychology and Optimal Government Design”) discussed the general implications of several well-known cognitive biases for policymakers. Kuran and Sunstein discussed specific measures that could help executive agencies resist “availability cascades.” Timur Kuran and Cass R. Sunstein, “Availability Cascades and Risk Regulation,” Stanford Law Review 51 (April 1999): 754-8.
114. Wagner, “Administrative Law, Filter Failure, and Information Capture.”
115. SeeGeorge A Akerlof and William T Dickens, “The EconomicConsequences ofCognitive Dissonance,” American Economic Review 72 (June 1982): 307-19.
116. Errol Meidinger, “Regulatory Culture: A Theoretical Outline,” Law & Policy 9 (October 1987): 366.
117. A similar dynamic may exist in corporate boards of directors, where collegiality can produce higher productivity and performance but where social ties can lead some members to “develop a sense of ‘in-group’ bias that colors how they evaluate claims by others … that threaten one ormore groupmembers.” Donald C. Langevoort, “The Human Nature of Corporate Boards: Law, Norms, and the Unintended Consequences of Independence and Accountability,” Georgetown Law Journal 89 (April 2001): 810-11.
118. Negotiated Rulemaking Act of 1990, codified at 5 U.S.C. §§ 561-570. For an overview of negotiated rulemaking and some critiques, see Jody Freeman, “Collaborative Governance in the Administrative State,” UCLA Law Review 45 (October 1997): 33-40.
119. Ayres and Braithwaite, “Tripartism: Regulatory Capture and Empowerment.” On tripartism and financial regulation, see also Baxter, “Capture in Financial Regulation.”
120. Rachel E. Barkow, “Insulating Agencies: Avoiding Capture Through Regulatory Design,” Texas Law Review 89 (November 2010): 62-4.
121. Bagley and Revesz, “Centralized Oversight of the Regulatory State,” 1316.
122. For an overview of empirical attacks on the efficient markets hypothesis, see Justin Fox, The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street (New York: Harper Business, 2009), 191-210.
123. Justin Lahart, “Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party.” Wall Street Journal, January 2, 2009. Available at http://online.wsj.com/article/SB123086154114948151.html.
124. Christine Jolls and Cass R. Sunstein, “Debiasing Through Law,” Journal of Legal Studies 35 (January 2006): 201-2.
125. For example, forcing (experimental) plaintiffs and defendants to consider and list the weaknesses in their respective cases eliminated self-serving bias on each side, making it easier to reach settlement. Linda Babcock, George Loewenstein, and Samuel Issacharoff, “Creating Convergence: Debiasing Biased Litigants,” Law and Social Inquiry 22 (1997): 918-20.
126. Steven M. Davidoff, “The Government’s Elite and Regulatory Capture,” DealBook, New York Times, June 11, 2010. Available at http://dealbook.nytimes.com/2010/06/11/the-governments-elite-and-regulatory-capture/.
127. On regulatory devil’s advocates in general, see Brett McDonnell and Daniel Schwarcz, “RegulatoryContrarians,”North Carolina LawReview89 (2011): 1629-79.
128. Similarly, Troy Paredes has suggested that corporate boards should include a “chief naysayer” to counter CEO overconfidence. Troy A. Paredes, “Too Much Pay, Too Much Deference: Behavioral Corporate Finance, CEOs, and Corporate Governance,” Florida State University Law Review 32 (Winter 2005): 740-7.