[PEN-L:28706] Broken System? Tweak It, They Say

["Seth Sandronsky" <ssandron@xxxxxxxxxxx>]

Broken System? Tweak It, They Say

July 28, 2002
By LOUIS UCHITELLE

Going back two centuries, economists have worried about
what Adam Smith described as the tendency of chieftains in
a market system "to deceive and even to oppress the
public." When the grasping got out of hand a century ago,
government regulation made a great leap forward in the
Progressive Era. There was another leap in response to the
excesses of the 1920's. And now regulation is again on the
agenda.

For the first time since the Carter administration began
deregulating in the late 1970's, the process has halted,
and the winds are pushing in the opposite direction. The
spreading damage to people's lives from plunging stock
prices and disappearing pension savings has made regulation
acceptable again. In a Harris Poll of 1,010 people this
month, 82 percent supported "tough new laws" to reduce or
prevent corporate fraud.

The House and the Senate, in response to the outcry,
approved last week the first stab at renewed regulation - a
bill that would punish chief executives with jail for
hoodwinking the public and would erect obstacles to future
hoodwinking, particularly by accountants. President Bush
says he will sign the bill quickly.

But regulation is likely to stop there, or slow to a
trickle. Republicans and Democrats are resisting a second
act, arguing in effect that this one piece of legislation
may be enough to repair the system, along with a bit more
action to improve accounting for stock options and to
protect pension savings. Or as Senator Carl Levin, the
liberal Democrat from Michigan who wants these extra steps,
said in an interview, "I do not think anyone here lusts to
regulate."

Similar reluctance showed up in interviews last week with
mainstream economists, even those who 25 years ago were
leery of too much deregulation. In the growing debate over
the government's role in the rocky, post-boom economy, the
views of economists are important. They are the experts who
would provide the rationale, and the cheerleading, for a
new era of regulation, just as they have provided the
reasoning and crucial support for deregulation. So far, the
broad middle ground in economics is wary of reversing
course.

"I want thoughtful regulation and not an inadequately
thought-out regulatory response to the problems of the
moment," said Janet Yellen, an economist at the University
of California at Berkeley who was an adviser to President
Bill Clinton. Ms. Yellen offered a caution repeated often
in the interviews. "It slightly worries me that when people
find a problem, they rush to judgment of what to do," she
said. "We have to be careful of ill-considered regulation."


If stepped-up regulation is unlikely, so is more
deregulation, even the proposal to let individuals invest
some of their Social Security contributions in the markets.
The deregulation wave appears to be suspended, and that in
itself may be a historic turning point. The deception
uncovered in recent scandals has elevated deregulation into
a national crisis, by punching many holes in a process that
had seemed to function as long as it was confined to
particular industries and the players were more or less
honest.


POLITICIANS and many economists now appear to hope that by
monitoring the accountants and punishing errant executives,
as the new Congressional legislation is intended to do,
deregulation will become acceptable again. But there would
be a greater emphasis on fine-tuning and occasional
government intervention as problems arise.

For all the mayhem of recent weeks, most mainstream
economists say they still hold to the theory that
unfettered competition, achieved through deregulation,
tends to lower prices and promote efficiency and
innovation.

"If you go around asking academic economists, `Do you think
we should reregulate the airlines or trucking or any other
deregulated industry?' you would get no votes," said Alan
S. Blinder, an economist at Princeton and a Clinton adviser
who served briefly in the 1990's as vice chairman of the
Federal Reserve.

There are dissenting voices, however, among some economists
slightly to the left of the mainstream. James K. Galbraith
of the University of Texas at Austin argues for balance
between regulation and deregulation in an economy that
relies for prosperity as much on the public sector as the
private sector. And Robert Kuttner, co-editor of the
American Prospect magazine, contends that mainstream
economists are caught in a bind.

"You have a whole generation of economists who have devoted
their careers to supporting deregulation," he said, "and
now they are twisting themselves into intellectual pretzels
to deny that they are recanting on deregulation."

Instead of giving up on deregulation, many economists are
proposing ways to fix it; that is, to tweak it so it works
better. At times they are also calling for a regulation or
two that would be narrowly focused on a particular problem
that, in their view, is distorting markets that in other
respects are efficient and competitive.

The nation's academic economists are nearly all members of
the American Economic Association, which has added only one
session on regulation to the already-prepared agenda for
its annual meeting in January. That session, titled
"Lessons from Enron," will include a paper by James Poterba
of the Massachusetts Institute of Technology that will
examine the dangers when employees are required to invest a
large portion of their 401(k) accounts in their employer's
stock, a practice that wiped out the retirement savings of
many Enron workers when that company's stock collapsed.

To address this problem, Mr. Poterba favors portfolio
diversification. But what if the price of diversification
is an unwillingness by the company to contribute very much
at all to a 401(k)? Companies often consider stock
contributions much more affordable than cash subsidies.
Should regulation go a big step beyond diversification and
require a minimum pension subsidy, in cash, from the
company?

There Mr. Poterba is not willing to go. "If contributing to
pensions gets too expensive," he said, "companies will just
not do it."


A similar preference for sticking with the current degree
of deregulation, with repairs, pervades the thinking of the
nation's economists.

Consider the airline industry. Deregulation started with
the airlines in the Carter administration, which lifted
federal restrictions on routes and on fare changes. The
goals were to lower fares through competition, and to admit
more new airlines to the industry.

Fares did come down, although often not by much, and
certainly not for most business travel. As an alternative
to lower fares, airlines lured travelers with
frequent-flier miles. Some economists consider
frequent-flier miles a deregulation flaw and would fix it
by getting rid of these lures. Frequent-flier miles would
presumably lose their appeal if the Internal Revenue
Service ruled that the awards were income, subject to tax.

Or consider telecommunications, which Congress deregulated
in 1996. Havoc followed. With the stock market bubble
offering encouragement, telecommunications companies
overexpanded, built up huge debts and engaged in ruinous
price-cutting in a futile attempt to make use of idle
networks. As the shake-out proceeds through mergers and
bankruptcy, the odds grow that a few surviving companies
will acquire enough pricing power to raise rates for the
telephone, Internet and television cable services that so
many Americans feel they must have.

That would give the survivors the sort of monopoly power
that AT&T enjoyed until the courts broke up the company in
the early 1980's. In the absence of competition, government
had set rates and operating standards, a regulatory
practice that many economists said stifled entrepreneurship
and innovation.

But now that the telecommunications industry is shrinking
to fewer companies, the new danger is too much pricing
power. As a result, price regulations still in effect for
local service may have to remain, said Eli M. Noam, a
Columbia University economics professor.

"There was the expectation," he said, "that these tariffs
would phase out through competition, but now that no
competition is expected, the regulated rates are not likely
to go away."


Or consider electricity. Deregulation got into a lot of
trouble in California in the summer of 2000. The electric
utilities had sold off generators and power stations and
were buying electricity for customers on the open market,
presumably at competitive prices. But in 2000 the suppliers
spiked prices, partly because of power shortages but also
through manipulation. That led to some fixes even before
corporate scandals and plunging stock prices awakened much
broader public interest in repairing deregulation.

California began to buy electricity under long-term,
fixed-price contracts on behalf of the utilities, thus
averting price spikes. And the federal government imposed
price caps. Now Severin Borenstein, director of the Energy
Institute at the University of California at Berkeley,
offers another solution for fixing a basic problem in
electricity deregulation: inelastic demand, which means
that households do not turn off lights and appliances or
even cut back in the midst of a price spike.

Big commercial users, however, can quickly ration use, Mr.
Borenstein contends. He would install computerized meters
in their operations that keep the owners informed of the
fluctuating cost of electric power through the day as their
utilities buy it. When the price became too high, the
commercial establishments would cut back or shut down for a
while. Demand would realign with supply and prices would
soften for everyone - in theory, at least.

But for all his enthusiasm for this proposed fix, Mr.
Borenstein does not recommend the installation of the
meters elsewhere in the country until Californians try them
first, to make sure they work.

Electricity deregulation has been proceeding state by
state, and as Mr. Borenstein observed, "what happened in
California has given everyone else pause."

"The states that have not deregulated are not going to
start now," he said. "The ones that are moving toward it
are putting it on hold. And the ones that have deregulated
are grappling to fix deregulation."

> From the 1970's until Enron, deregulation had mainly
focused on specific industries: airlines, banking,
trucking, electric power, financial services. The savings
and loan crisis in the late 1980's produced some
backtracking to deal with the shady and destructive lending
that deregulation had allowed. Then with Enron came the
quantum leap. Deregulation, it turned out, had fostered
widespread greed.

A similar surge of bad behavior had brought on the
Progressive Era with Theodore Roosevelt and, in the 1930's,
the New Deal - periods in which America "cleaned up its
act" through regulation, as Claudia Goldin, an economic
historian at Harvard, put it.

Regulation flourished in those eras in step with the
public's suffering. Now the damage is limited; in the
Harris Poll, only 25 percent said they had been hurt by the
fraud and accounting problems.

Regulation, as a result, is making itself felt only in
accounting reform and new jail penalties for executives,
Mr. Kuttner of American Prospect argues. Still largely
untouched are the next rungs: stock options and the
conflicts inherent when a company is allowed to operate a
commercial bank, a brokerage house and an investment bank.
The Glass-Steagall Act separated those functions in the
1930's, but Glass-Steagall was repealed in 1999.

Whatever the differences, a common thread runs through the
corruption fostered by the robber barons in the late 19th
century, the stock kiting and fraud of the 1920's and the
scandals today. In economics, that common thread is called
asymmetric or imperfect information, which means in effect
that one party in a transaction knows more than the other
party and can take advantage of the second party.

Corporate executives, for example, know more about their
companies' circumstances than shareholders, lenders and
even employees, and can use that knowledge to swindle the
others and loot their companies, by selling stock perhaps,
knowing that it will plunge in value when misdeeds surface.

Two modern-day economists, George A. Akerlof at the
University of California at Berkeley and Joseph E. Stiglitz
at Columbia, incorporated asymmetric information into
economic theory and won a Nobel last year for their
efforts. Now Mr. Akerlof sees much greater enforcement as a
necessary response to the misbehavior that has flourished
in recent years.

But like most mainstream economists, he shies away from
more regulation. Instead, he would greatly increase
enforcement by the Securities and Exchange Commission and
other agencies to discourage insiders from taking advantage
of their privileged information.

"It is not regulation versus deregulation that is the
issue; we should have both," he said. "But if you have
rules that allow a lot more freedom, then you need much
more vigilance and enforcement, and we have starved budgets
for enforcement."


http://www.nytimes.com/2002/07/28/business/yourmoney/28ECON.html?ex=1028865439&ei=1&en=c086d23a92fdee71



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