Advancing a Free Society

“Capture” of Regulators by Fannie Mae and Freddie Mac

Monday, June 13, 2011

Political economists describe the process whereby government officials end up being the servants rather than the masters of the firms they are regulating as the “capture” by the industry of their regulators. When regulators are captured, much of what they do is motivated, consciously or not, by a desire to help the companies they are regulating, even when the social goals that the regulators should pursue are very different.

A famous illustration of capture is given by the way airlines were regulated under the Civil Aeronautics Board (CAB) from 1940 to 1978. Large airlines of those times, like American and Delta, naturally had a strong incentive to try to keep new airlines from entering the industry. As a compliant ally of the airline industry, the CAB did not approve one new interstate airline during this almost 40-year period. Many airlines entered the industry when President Carter abolished the CAB, and some of the old standbys, such as Pan Am and Eastern, ceased operations because they could not adjust to a competitive environment.

An economically disastrous example of the capture theory is provided by the disgraceful regulation of the two mortgages housing behemoths, Fannie Mae and Freddie Mac, before and leading up to the financial crisis. In their fascinating recent book, Reckless Endangerment, Gretchen Morgenson and Joshua Rosner explore in great detail how Fannie Mae used political connections and intimidation of anyone who stood in their way to gain a highly dominant position in the residential mortgage market. The authors’ show that various government officials, including congressmen and presidential cabinet members, closed their eyes to what these two government-supported enterprises (GSE) were doing. They allowed them to take on enormous risks, while publicly defending their behavior as not being highly risky.

Continue reading Gary Becker at The Becker-Posner Blog

(photo credit: Carrie Cizauskas)