Thursday, August 12, 2010

Context Matters

The pipe dream that less regulation is better and that market pressures will make everyone behave has been the most damaging thing to the country in the past 30 years.

You have to ask yourself, if the market is so effective at self regulating, why did regulations ever get instituted in the first place? The context matters.

I'm happy to remove regulation whenever possible. But you have to prove to me that the problems that caused the implementation of the regulation in the first place somehow have another factor keeping them from happening yet again.

Here's one example - the smog deaths in 1948 in PA. http://www.npr.org/templates/story/story.php?storyId=103359330 Market pressure didn't have any impact on this company to keep it from polluting.

For Financial, think of the Savings and Loan crisis in the 80s and 90s. http://en.wikipedia.org/wiki/Savings_and_loan_crisis

A related recent example is Rand Paul and the idea that the market would pressure private businesses not to discriminate. If that were true, why didn't that come to fruition in the 100 year after the abolition of slavery? Business owners are not logical profit optimizing machines. Just like everyone else they're flawed human beings that will do things that don't make sense and can hurt the community or in this case a subset of the community.

BP's catastrophe in the gulf is another example. Often when short cuts are allowed and can increase profit (even as they increase risk) they're taken. And with a legal cap on damages, what the heck! That even sweetens the deal towards risky behavior.

Because the people who run these institutions are human and some are unethical (and there will always be some who are unethical) the only way to protect against it is with sensible regulation.

There are many, many more such examples, and believe me, I understand there are some regulations that overreach (note the use of sensible above!). But you should never just remove them without considering the original context and the goal otherwise it's just history repeating...


5 comments:

Jon said...

It seems like BP gets called out as a case for increased government regulation, but I have trouble imagining a government regulation that could even come close to having the deterrent effect of a $35 + billion dollar loss. Given that no one knew how to handle the disaster effectively (government, other oil companies, other experts - were grasping at straws - the government brought in James Cameron to see if he had any ideas – talk about grasping straws).

Could regulations be put in place that will prevent anything? Of course - but at what cost? People who make unscrupulous decisions to put people's health at risk do so in spite of regulations to the contrary. This is evidenced by all of the mega-damages in lawsuits against drug companies, chemical companies, the cigarette industry. Having more regulations, it seems, runs a substantial risk of stifling otherwise law-abiding and responsible companies, and will not target the harmful assholes who will skirt, find loopholes, or otherwise disregard the rules in the chase for the almighty dollar.

After a major issue like the smog deaths, savings and loan crisis, or BP and the gulf, the government will step in and impose regulations to make sure something similar doesn't happen again. I'm not sure how much value this adds - clearly companies faced with such a loss (like $35+ billion dollars) would also self-police in similar ways.

Erik said...

Jon writes:

It seems like BP gets called out as a case for increased government regulation, but I have trouble imagining a government regulation that could even come close to having the deterrent effect of a $35 + billion dollar loss.

So here's the problem. Ten years ago, someone with a spreadsheet and a couple of actuarial tables sat down, ran the numbers, and decided the probability of catastrophic failure (P), the cost to BP of a catastrophic failure (C), and the cost of fixing the practices on all hundred-some-odd oil rigs in the Gulf (F). B * C was less than F, which meant that they were beholden to their stockholders to maximize profit by cutting corners.

C only represents the cost of a negative outcome to BP itself. They're on the hook for cleanup costs, but by no means will they shoulder all of it. Thousands of people are out of work, and tourism/fishing won't recover for a generation; is BP going to pay all the fisherman who had to close up shop in June? Moreover, C is artificially deflated by having a court system that's sympathetic to BP's causes. If I were a betting man, I'd wager that they'll end up in a situation very similar to that of Exxon after the Alaskan spill. (that is to say, the $35 billion [and that's the first time I've seen that number--I was aware of $20 billion, where did you hear $35?] will never be paid out, because the courts will never let precedent against a corporation like that be established. Exxon paid $500 million in fines [all compensatory--there's a $25 million punitive damage limit under maritime law] for utterly destroying a thousand miles of coastline)

Erik said...

(Sorry, 4096-character limit on the last one)

A blanket assertion like "Companies will self-police because they know what the penalties are if they get caught" is demonstrably false. We just witnessed the textbook case of it being false--BP knew exactly what their costs would be if their high-pressure line blew out because of shoddy safety regulations. They chose to do what they did anyway, because they thought P was low enough. And, what's more, $35 billion in fines sounds like an astonishing amount of money, but BP's operating revenues last year were just under $240 billion. 15% of one year's revenue isn't the catastrophic loss you're painting it to be. Heck, their share price has INCREASED since the penalties were announced--surely this doesn't forebode their financial ruin.

We can generalize this, too--penalties for breaking existing regulations aren't as drastic as they need to be to stop companies from breaking the law, especially given the collateral damage that corporate malfeasance can have, and how utterly stacked the deck is in favor of companies who decide to do so. I guess what I'm driving at here is that market pressure doesn't come close to approximating all the forces that are at work in any capitalistic environment. A so-called "free market" is inexorably slanted toward those who can exercise the most power within it. Since corporate protections under law often exceed those of private citizens (you can't send a corporation to prison for breaking the law; unrestricted corporate campaign contributions are A-OK but individuals have a hard limit on what they can spend; if your construction firm wants to build a mall, they can seize the land to build it on from private owners; I can keep going based entirely on the last three years' worth of utterly insane decisions from the Supreme Court).

I think my position is probably far more extreme than Anna's. I don't think our regulatory agencies do anywhere close to what they should be doing. I want them to be in a position to make wrong-doers actually responsible for their, well, wrong-doing. I want the board of directors for a drug company that knowingly put out Vioxx to go to prison on manslaughter charges, and I want their company bankrupted with the profits going to the survivors. I want BP to pay the actual restorative costs for the Gulf Coast ecosystem (which, depending on who you read, is a figure with between 11 and 14 zeroes on it--that is to say, five orders of magnitude beyond what they've so far been assessed). I want EPA violations to come with prison sentences and fines that are guaranteed to break the backs of any company hit with one.

I also don't think this will affect the lives of most business-owners, much less their employees. Don't want to run afoul of regulations? Then DON'T BREAK THE LAW. (This is a point that should be near and dear to your heart, Jon :-) )

Jon said...

Let's stipulate that BP did the analysis with actuarial tables. With a set of finite monitoring and control resources wouldn't the US government need to do the same thing? We have a limited number of regulators, so we need to check things that are much more likely to happen.

BP's stock has nowhere to go but up - they were trading at 60.48 the day of the accident and today are at 38 and change. That represents a roughly 80 billion loss of shareholder value and that doesn't count the operating loss.
- They've lost around 20 billion, but expect the number to be over 32 billion and change based on this article (this is BP's own estimate): http://www.washingtonpost.com/wp-dyn/content/article/2010/07/27/AR2010072700479.html
I can't remember where i saw the 35 billion figure.

Also, I agree with you that penalties should be much stricter when things go wrong. I think a first drunk-driving conviction should carry a mandatory 1-year prison sentence time served. I'm completely with you with the idea of severe consequences when people act in an evil way. I just don't see eye to eye with the approach that the way to do that is to increase the bulk of government regulatory agencies. But I understand - you're hoping that it will nip things in the bud.

Old Gaming Mama said...

It's interesting because this verges into the other topic I've been thinking a a lot about that I mentioned. The corrosive illusion of perfect solutions which I will try to write about shortly.

To me it's always (as with sooo many things) a balancing act. Single simplistic approaches don't work. Only the penalty angle or 100% regulation up front, neither is a universal solution. The needed combination of regulations/penalties is nuanced and very dependent on the industry.

The more catastrophic a failure could be to the community and the world, then the more it must be regulated up front since it's not only bad actors, but incompetent ones that can cause problems.

I never suggested in what I wrote that regulations are a panacea for everything. My argument is you don't strip regulations without consideration to why they were put in place in the first place and what exploring the implications are of removing them.

Your last paragraph hits the nail on the head. Regs get put in place after a catastrophe, sure. But then 40 year later someone says 'Hey these are oppressive to business, we don't need these' and by removing those regs sets the stage for a repeat.

Remember BP faced a maximum of only 75 million in damages outside of clean up costs. (See http://www.epa.gov/emergencies/content/lawsregs/opaover.htm ) Caps like that fostered the taking of risks that should not be taken.

I'm rambling and need to get to work, but I'll try to write about the perfect solution problem you get to in you response Jon. :)