U.S. turns away from decades of deregulation

WASHINGTON — The housing and financial crisis convulsing the U.S. is powering a new wave of government regulation of business and the economy.

Federal and state governments alike are increasingly hands-on in their effort to deal with failing businesses, plunging house prices, worthless mortgages and soaring energy prices. The steps add up to a major challenge to the movement toward deregulation that has defined American governance for much of the past quarter-century since the "Reagan Revolution" of the early 1980s. In fact, some proponents today of a bigger oversight role for government are Republican heirs to the legacy of President Reagan.

On Thursday, the government's role in policing the financial markets took center stage at a House Financial Services Committee hearing. In testimony there, Securities and Exchange Commission Chairman Christopher Cox said the SEC should be given more power to regulate the parent companies of investment banks.

New York Fed President Timothy Geithner described the need for policymakers to be particularly vigilant, noting the entire regulatory structure should be re-evaluated. "You have to be prepared to look at everything," he said.

Both men testified how government regulation can be strengthened without stifling financial innovation.

Loans provide leverage

Already, the Federal Reserve has dialed up its scrutiny of Wall Street investment banks, placing officials inside the giant firms and weighing in on their capital requirements, after taking the unusual step of offering tens of billions of dollars in emergency loans. The Fed also has agreed to lend money to Fannie Mae and Freddie Mac, potentially giving the agency more oversight of the two giant housing-finance companies as well.

At the same time, state utility commissions are re-establishing control over power companies that they ceded during earlier waves of deregulation. The Education Department is taking a step toward nationalizing the market for student loans, after private lenders abandoned that business.

The debate over Washington's hand in the economy is at the heart of the presidential campaign. Both major-party candidates are endorsing proposals to create new, Federal Reserve-style commissions to limit greenhouse-gas emissions and decide how to spend billions of dollars on energy-efficient technology.

"There's a backlash against the laissez-faire, 'isn't-it-wonderful-how-creative-markets-are' viewpoint," said former Fed Vice Chairman Alan Blinder, a Democrat. "Markets are creative, but sometimes the creativity leads to strange and dangerous directions."

Alabama Sen. Richard Shelby, the top Republican on the Senate Banking committee, noted the shift in power away from markets but worries about the result. "It's in the wrong direction, from my point of view," he said.

Public opinion is shaping the response. By a 53 percent-to-42 percent margin, Americans want government to "do more to solve problems," according to a Wall Street Journal/NBC News poll released last week. A dozen years earlier, respondents opposed government action by a 2-to-1 margin.

There is a possibility the shift will be temporary. Kevin Hassett, a conservative economist at the American Enterprise Institute, said there have been other times when an era of activist government appeared to be dawning, but didn't. After the savings-and-loan system collapsed in the 1980s, the government spent $125 billion seizing failed S&Ls and selling off their loans. But that didn't augur a return of bigger government. President Clinton's effort to create a universal health-care system in the 1990s flamed out.

Even if activism is on the rise, it doesn't mean a rollback of decades of deregulation of businesses ranging from airlines to trucking to telecommunications. Those moves have lowered the cost of goods and services across the economy.

The degree of change will depend on who occupies the White House next January. Sen. Barack Obama, the presumed Democratic candidate, has talked about a sharp increase in taxes on wealthy Americans, and a windfall-profits tax on oil companies. Republican rival Sen. John McCain would cut taxes on corporations.

Still, powerful industries are facing greater pressure for regulation than they've seen in a generation because of concerns about the safety of the products. Drugmakers are being pressed by congressional Republicans and Democrats alike, who want stricter oversight by the Food and Drug Administration, and new regulations that would mandate tougher safety standards and import controls.

In the case of the food industry, the food processors and other companies — fearing a public backlash — have been urging Washington to ratchet up its oversight of imported foods and ingredients, reversing the industry's usual hands-off approach. While the Bush administration hasn't been willing to go as far as the processors want, Florida recently imposed requirements on tomato growers for annual inspections, among other measures.

Fed responds forcefully

The bigger role for government is being driven in part by fallout from the housing crisis. The beating suffered by financial institutions has required the kind of quick, large-scale financial intervention that only the Federal Reserve can provide. At the same time, the success of the Fed in recent years at whipping inflation and limiting the depth of recessions has had the side effect of enhancing the reputation of government agencies. That's prompting politicians to try to use that model to solve other problems.

It all adds up to more government activism, but an activism that relies more heavily on unelected bureaucrats rather than elected lawmakers. In coming years, the big issue will be "where should we draw the line between the political and the technocratic," said Blinder, the former Fed vice chairman.

This nuanced view is reflected in the proposals of the presidential candidates. Obama wants a big push in spending on bridges, ports, railroads and other infrastructure, but worries about politicians doling out the money according to political whim. (That danger is also a longtime concern of McCain.) To insulate the spending, he would create a $6 billion bank patterned on the Federal Deposit Insurance Corp., which has five members whose terms are staggered to try to assure political independence.

McCain has said he is open to a bailout of General Motors Corp., if it were threatened with bankruptcy amid falling sales and high costs, and wants to direct federal funds to develop new-generation automobile batteries and electric cars. "There's always a basic issue about what is the way to effectively harness private markets," said McCain policy chief Douglas Holtz-Eakin.

Cycles have long history

The struggle between markets and the government is as old as the country itself. Founding Father Alexander Hamilton pushed for higher tariffs to protect nascent U.S. manufacturers, saying he wanted to preserve "a monopoly of the domestic market." That directly clashed with the get-the-government-off-our-back agrarianism of Thomas Jefferson.

Since then, various crises have sent the pendulum swinging back and forth. The handling of the financial panic of 1907 — when a private individual, banker J.P. Morgan, bailed out a floundering U.S. economy — stirred so much political outrage on the left that in 1913 the government created the Federal Reserve to run the financial system. The Depression-era collapse of markets led to the birth of a slew of new agencies, including the Securities and Exchange Commission and the Federal Deposit Insurance Corp., which regulated and remade American-style capitalism.

Disgust at bungling government policies that by 1980 produced a combined rate of inflation and unemployment of 20 percent — the "misery index" — led to the election of Ronald Reagan. He rolled back regulation and antitrust enforcement as a way to free market forces from the shackles of government.

The movement started by Reagan has taken several hits. The 2001 terror attacks led to the nationalization of airport workers and the creation of the elephantine Homeland Security Agency, bucking decades of privatization of government functions. The corporate-accounting scandals early this decade that leveled energy trader Enron and communications giant WorldCom led to the Sarbanes-Oxley law in 2002, which reversed the pattern of the prior two decades of easing regulation of U.S. companies. Among that law's many provisions, chief executives had to accept legal responsibility for the accuracy of their firms' financial statements.

Former House Republican Speaker Newt Gingrich, who captained the Republican takeover of Congress in 1994 on a "small-government" platform, figures that any surge in government activism is bound to be short-lived because bureaucrats will blunder. "It's very dangerous to assume that some skill at managing the money supply — as the Fed has done — will lead to bureaucratic skills greater than any country possesses," he said.

Powers may expand

Dealing with global warming may augur a further expansion of government power. The leading proposal in Congress would cap emissions of greenhouses gases by industries and allow them to buy and sell emission permits.

The legislation garnered 48 votes in the Senate in a June procedural measure, leaving it a dozen short of the 60 needed to get a vote on the bill. Both presidential candidates have made emissions-trading systems a centerpiece of their environmental platforms, all but assuring another congressional effort after the election.

"Markets are groping" for guidance, said Fred Morse, a senior adviser to the U.S. solar-power subsidiary of Spanish utility Abengoa SA. "You need government to lay out a policy."

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