Regulatory Breakdown in the United States

Penn's RegBlog is running an interesting series on Regulatory Breakdown: The Crisis of Confidence in U.S. Regulation (UPenn Press, 2012), edited by Cary Coglianese. The series features short versions of the contributions to the book.

Here is a brief taste, from a chapter on housing regulation:

Regulatory oversight of the housing finance system became reliant on what products the government-sponsored enterprises were willing to buy and the FHA was willing to insure. However, starting in the 1960’s and continuing through the 2000’s, the conditions needed for public option to work as a regulatory scheme started to change.  With the privatization of Fannie Mae, creation of Freddie Mac, and the crash of the savings and loan industry, the limited regulation that had existed under the public option approach proved to be woefully inadequate. 

The inadequacy of the public option became even clearer with the privatization of secondary mortgage markets, which started including riskier and non-standard mortgage products.  The prior regulatory approach became defunct, according to the Levitin and Wachter.  While the housing finance market expanded rapidly from the New Deal up through the financial crisis of 2008, regulatory oversight in this field decreased, instead of becoming stronger, with the increased competition and “race to the bottom” in underwriting and pricing standards that came with privatization.

After the 2008 crisis, the public option is back.  Just as when it was first created, the public option approach of today has arisen as an inadvertent byproduct of financial collapse, instead of through a deliberate process. As the reliance on the public option declines in the years ahead, a regulatory system that is reliant on command-and-control regulations and Pigouvian taxation will become necessary.  However, if a hybrid approach is chosen, and public options compete with private actors, the authors argue that traditional and uniform regulatory oversight will still be needed.  In that case, regulators must ensure that all actors are competing under the same sets of rules, and that there is no race to the bottom among the private actors in a hybrid housing finance market.