The late economist George Stigler wouldn't be surprised at today's world.  

Stigler, you see, won a Nobel Prize for the concept of "regulator capture," or the idea that "regulation may be actively sought … by the industry and is designed and operated primarily for its benefit."

Sound familiar? If you've noticed a pattern of government favoring Wall Street, you've cracked an important code. One of the great confusions of the past two years is how the financial industry managed to fully wreck shop while remaining mostly untouched from the hands of regulators. After 9/11, airline security was immediately revamped from head to toe. Three years after the financial collapse began, here we are; almost nothing has changed.

Friends don't let friends turn down plutocracy
If you're trying to make sense of this, look no further than what's often called Wall Street's revolving door to Washington. In short, those whose duty it is to regulate Wall Street have a curious tendency to be elite members of … Wall Street.

We've compiled a brief list of examples:


Was (or Still Is)

Then Became (or Now Serves as)

Donald Regan

CEO, Merrill Lynch

Treasury Secretary (under Reagan)

Nicholas Brady

Chairman, Dillon Read

Treasury Secretary (Reagan)

Robert Rubin

Co-Chairman, Goldman Sachs (NYSE: GS)

Treasury Secretary (Clinton)

Roger Altman

Partner, Lehman Brothers

Deputy Secretary of Treasury (Clinton)

Frank Newman

Chief Financial Officer, Bank of America (NYSE: BAC)

Undersecretary of Domestic Finance (Clinton)

Robert Steel

Vice Chairman, Goldman Sachs

Undersecretary of Domestic Finance (G.W. Bush)

Hank Paulson

CEO, Goldman Sachs

Treasury Secretary (G.W. Bush)

Josh Bolten

Executive Director, Goldman Sachs

White House Chief of Staff (G.W. Bush)

Neel Kashkari

Vice President, Goldman Sachs

U.S. Treasury, Head of TARP (G.W. Bush)

Bill Donaldson

Chairman, Donaldson Lufkin Jenrette

Chairman, SEC (G.W. Bush)

Edward Forst

Every imaginable senior position, Goldman Sachs

TARP Advisor (G.W. Bush)

John Snow

Chairman, Business Roundtable

Treasury Secretary (G.W. Bush)

Kendrick Wilson III

Managing Director, Goldman Sachs

Advisor, Department of Treasury (G.W. Bush)

Barbara Shycoff

Vice President, American Express (NYSE: AXP)

Managing Director, Office of Thrift Supervision (G.W. Bush)

John Dugan

Banking industry lobbyist

Comptroller of the Currency (G.W. Bush)

Michael Froman

Managing Director, Citigroup (NYSE: C)

White House Liaison to G7, G8, G20 (Obama)

Herb Allison

Chief Operating Officer, Merrill Lynch

Assistant Secretary for Financial Stability, Department of Treasury (Obama)

Lewis Sachs

Director, Bear Stearns

Treasury top aide (Obama)

Richard Fisher

Investment banker, Brown Brothers Harriman

President, Federal Reserve Bank of Dallas

Dennis Lockhart

Senior Corporate Officer, Citigroup

CEO, Federal Reserve Bank of Atlanta

William Dudley

Managing director, Goldman Sachs

President, Federal Reserve Bank of New York

Jon Corzine

Senior partner, Goldman Sachs

Governor, New Jersey

Stephen Friedman

Chief Operating Officer, Chairman of Goldman Sachs

Chairman, New York Fed

Edward Murphy

Chief Financial Officer, JPMorgan Chase

Executive Vice President,  New York Fed

Peter Peterson

Co-Founder, Blackstone

Board of Directors, New York Fed

Walter Shipley

Chairman, Chase Manhattan

Board of Directors, New York Fed

Sanford Weill

Chairman, Citigroup

Board of Directors, New York Fed

Richard Fuld

Chairman, CEO, Lehman Brothers

Board of Directors, New York Fed

Jeffrey Immelt

Chairman, CEO, General Electric (NYSE: GE)

Board of Directors, New York Fed

Jamie Dimon

Chairman, CEO, JPMorgan

Board of Directors, New York Fed

Kevin Warsh

Executive Director, Morgan Stanley

Governor, Federal Reserve Board

Elizabeth Duke

Chairman, American Bankers Association

Governor, Federal Reserve Board

Robert Kimmitt

Managing Director, Lehman Brothers

Deputy Secretary of Treasury (G.W. Bush)

Gary Gensler

Partner, Goldman Sachs

Undersecretary of Treasury (Clinton), Head of Commodity Futures Trading Commission (Obama)

We found hundreds of examples, but we'll stop there. You get the point.

First-class financial incest
Now, just because someone has worked in the financial industry doesn't necessarily mean they can't take on Wall Street when it's their job to do so. In spite of his former career as an investment banker, Dallas Fed president Richard Fisher argued earlier this month that "banks that are 'too big to fail' are simply 'too big.' We must cap their size or break them up." He's an independent voice who doesn't robotically hew to the interests of the financial lobby. 

But he's also a rare gem. Consider John Dugan, a former bank lobbyist who now serves as comptroller of the currency. His office (the OCC) regulates and supervises the big national banks.

You probably know where this is going. Instead of policing banks, Dugan's OCC has played the role of mama bear protector.

  • The New York Times reports that of the hundreds of thousands of consumer complaints fielded over the past decade, fewer than 200 enforcement orders were issued.
  • When West Virginia tried to sue Capital One (NYSE: COF) for credit card abuses, the company applied for a charter under the OCC, ostensibly seeking its infamously gentle embrace. Now a national bank under Dugan's sole purview, Capital One escaped West Virginia's  jurisdiction, and the state was politely told to pipe down and move along. The head of the Financial Crisis Inquiry Commission told Dugan, "You tied the hands of the states and then sat on your hands." And it worked magnificently.
  • Under the OCC's light watch, commercial banks took on insane derivatives exposure. Untold commercial banks were backstopped by taxpayers when things turned explosive. Dugan seems content with this result: "In the end, the fact that they got the [bailout] money but took steps to fix themselves … to pay the government back quickly, will be viewed as a successful way to deal with a very difficult situation." Forget moral hazard. His friends lived.

The customer is always right (ahem)
This kind of behavior isn't restricted to Wall Street. After the BP (NYSE: BP) oil spill, the world has been appalled after learning how the Minerals Management Service (MMS) was literally in bed and snuggling with the oil companies it oversaw.

Appalling, yes. But MMS' relationship with Big Oil was juvenile compared with banks and their regulators.

OCC derives its operating budget not from Congress, not from states, but from the banks it regulates. Big deal, you say? The problem is that banks can shop around for friendlier regulators if OCC's restrictions rain on their master plan. Banks are literally regulators' paying customers, which must be kept happy for a regulator to justify its existence. Consider this profile of former Countrywide CEO Angelo Mozilo (courtesy of The New Yorker):   

Mozilo called some of the regulators' concerns "much ado about nothing." He decided that Countrywide should try to switch regulators, leaving the Fed and the O.C.C. for the weaker Office of Thrift Supervision (O.T.S.) … the O.T.S. had lobbied Countrywide to make the switch.

That's impressively stupid.

Get us out of here
What's the solution? Consolidating regulators and giving them their own operating budgets so they don't have to compete against one another for business seems like a no-brainer. But we're admittedly stumped on the issue of regulatory capture and won't pretend to have all the answers. When regulators are hiring, they can't just reject every Wall Street veteran. We want regulators who know what they're doing. We just don't want the police to coincidentally be the criminal's frat brother.

That said, here are two things we can do that would help us turn this ship around.

(1) Find ways to have less money in politics.
The financial industry spends more than $1 million a day on lobbying.  All too often that means industry sellouts are appointed as regulators.

Fixing this problem is easier said than done. Voting for politicians with backbones is probably a good start, as is demanding some kind of campaign finance reform or improved transparency of who's paying for those annoying ads.

(2)When a simple law will work, don't tinker with regulatory discretion.
Firm laws can be far superior to discretion. We shouldn't always give regulators discretion to exempt and make random subjective calls as they please.

Consider this: Currently, the Federal Reserve subsidizes Dugan's too-big-to-fail banks by allowing them to use our FDIC-insured deposits for gambling with risky derivatives -- the same ones that contributed to the 2008 financial meltdown. That's a recipe for disaster. Because there's no good reason for taxpayers to subsidize derivatives casinos, why not just end the practice and be done with it?

This is actually something that's being voted on over the next week. If you want to stop subsidizing risky derivatives casinos, click this petition:

Petitions by|Start a Petition »


Ilan Moscovitz and Morgan Housel don't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.