Copyright (c) 2000 College of William & Mary

William & Mary Law Review

 

February, 2000

 

41 Wm and Mary L. Rev. 503

 

 

ARTICLE: Depoliticizing Financial Regulation

 

Steven A. Ramirez *

 

* Associate Professor of Law, Washburn University School of Law. Professors William Rich and Myrl Duncan reviewed an early manuscript of this Article and provided many helpful insights. Professor Jeffery Worsham and Professor Joe Peek also provided insights, in the areas of political science and economics, respectively. Eric Kraft provided valuable research assistance.

 

SUMMARY:

 ...  Over the past few decades, scholars have called into question the ability of regulatory agencies to function effectively in furtherance of the public interest. ...  This Article explores whether a certain degree of agency independence from the legislative and executive branches can break down iron triangles and provide a basis for effective depoliticized regulation, in the specific context of financial market regulation, where now there is a compelling need for such a regulatory framework. ...  The current, largely politicized system of financial market regulation has fragmented regulatory power in an unprincipled and chaotic fashion. ...  In the area of financial market regulation, the Fed has achieved a remarkable level of political independence. ...  Though Professor Worsham's study is limited to the banking industry, his findings provide a strong basis for generally explaining the dynamics of financial market regulation. Indeed, history demonstrates that the regulatory maladies he identifies permeate financial market regulation. ... Professor Worsham's findings can be extended from banking regulation to financial market regulation generally. ... Inappropriate political and special interest influence pervade financial market regulation. ...  For example, if there were only one financial institution regulator, free of monetary policy responsibilities, and one capital market regulator that exclusively regulated publicly held companies, both regulatory competition and regulatory turf battles could be curtailed. ...  

 

TEXT:

 [*503]  Over the past few decades, scholars have called into question the ability of regulatory agencies to function effectively in furtherance of the public interest.  n1 Since midcentury, they have amassed convincing evidence that agencies can be captured through, for example, "iron triangles" between Congress, agencies and those supposedly regulated.  n2 More recently, regulatory scholars have articulated various theories of regulatory conduct and used differing terminology to describe capture. Nonetheless, there is broad agreement that special interests can act within the context of political subsystems, where isolated regulatory actors are subject to various forms of pressure, causing regulatory policies to serve special, rather than public interests.  n3 These political subsystem actors often can subvert regulation when  [*504]  political conditions fail to provide appropriate checks and balances.  n4 Congress itself is frequently co-opted in much the same fashion as are regulatory agencies.  n5 This Article explores whether a certain degree of agency independence from the legislative and executive branches can break down iron triangles and provide a basis for effective depoliticized regulation, in the specific context of financial market regulation, where now there is a compelling need for such a regulatory framework. The Article concludes that the Federal Reserve Board's administration of monetary policy exemplifies the possibility of depoliticized regulation. The Federal Reserve Board has demonstrated that if Congress provides broad delegation of authority to a singular agency with a high degree of political independence, then effective regulation is  [*505]  likely, free of special interest influence and of transitory political forces having less than rational agendas. While focusing upon a relatively narrow area of regulation, this Article argues that effective, relatively nonpolitical regulation can be achieved within the framework of our Constitution. Finally, using financial market regulation as a model, this Article addresses the conditions under which depoliticized regulation is most appropriate.

Financial market regulation provides an excellent context for considering these issues because of its spectacular regulatory failures and the current dynamics facing the regulatory structure governing our financial markets. The world financial system is becoming exceedingly complex. Even the most respected regulatory experts, including Federal Reserve Chairman Alan Greenspan, have observed that with the accelerating globalization of capital markets, regulators have insufficient knowledge to prevent a major catastrophe.  n6 One major challenge is that the world is more economically interdependent than ever. New technology has given rise to new types of transactions, particularly derivatives transactions, that link financial institutions to markets around the globe.  n7 One market crash, in far off East Asia for example, can roil financial markets in London, New York, and Frankfurt. In the summer of 1997, East Asian instability  [*506]  took the financial world by surprise. The fact that regulators, investors, and financial experts equally failed to predict the gravity of the problems arising from the collapse of the "Asian Tigers" demonstrates how rapidly the financial world is evolving. This evolution has overwhelmed the legal system's ability to keep pace, and raises a high-stakes and compelling question: Is Congress institutionally capable of meeting challenges to regulation in this area on a timely and thorough basis?  n8

Concomitantly, globalization and technology have created incentives for financial institutions and other business organizations to consolidate and reach beyond national frontiers. The profit potential and increased girth of such consolidated entities necessarily mean that these institutions have enormous economic power.  n9 In light of this and the increasing complexity of financial regulation, the democratic process seems particularly ill-suited for making informed decisions on matters of financial market regulation. Voters have insufficient knowledge, time, and interest to make appropriate electoral decisions on the basis of matters of financial market regulation.  n10 In the absence of transitory factors, such as severe economic dislocation, the public is not aware of the course, much less the details, of financial market regulation. This creates a disconcerting vacuum: the money and  [*507]  influence of the regulated -- the financial institutions or businesses themselves -- can fill the vacuum and thus capture regulation.  n11 Even when transitory factors awaken the electorate, the popular alarm frequently triggers an overreaction, or a less than rational reaction. This political failure leads to regulation that is dictated largely by the weight of money interests, or political overkill and "random agendas."  n12

To deal with these realities, the United States is burdened by a fragmented system of financial market regulation. The current, largely politicized system of financial market regulation has fragmented regulatory power in an unprincipled and chaotic fashion. Three factors have led to this irrational fragmentation. First, on those occasions when the electorate focused on financial market regulation, it often cast its eyes upon the system with a high degree of suspicion towards "big business."  n13 Second, statutory obsolescence has led to an outdated regulatory framework.  n14 Third, "big business" itself has seen strategic advantages in protecting itself from competition and weakening regulatory power.  n15 After decades of pursuing this fragmentation, powerful interests now are seeking the ability to assemble financial supermarkets  [*508]  or "universal banks," without any central regulatory authority.  n16 This fragmentation has led to a unique form of regulatory competition that has stifled the development of sound financial regulation. To make matters worse, the largest corporations in America can choose from fifty different sets of state laws for corporate governance. Financial market experts have recognized that it is inappropriate for the government to erect artificial barriers to competition and "to divide the financial world into discrete segments."  n17 What has been understated, however, is that segmented regulation similarly is obsolete. This dimension of political regulation adds an additional factor, specifically regulatory competition, in the pressures giving rise to regulatory capture. Fragmentation of regulatory power spawns real, not theoretical, problems and in the case of the savings and loan crisis alone contributed to a $ 1 trillion regulatory fiasco.  n18

The current regulatory structure fails to balance appropriately the costs and benefits of regulatory policy. Concentrated benefits frequently are extended to powerful interests at the expense of the general public, particularly if the costs are spread over the long term. Similarly, regulation in its current state permits the absorption of easily concealed costs for the benefit of those interests that stand to achieve real benefits in exchange. Thus, diffused and deferred costs are underweighted in policymakers' decision-making processes. Political gridlock and agency infighting has led to the reality that America has a twenty-first-century economy that is governed by Depression-Era regulatory structures.  n19 Consequently, American financial institutions and corporations are hobbled internationally and there are gaping holes in the country's regulatory infrastructure. In short, the regulation  [*509]  of financial markets is seriously dysfunctional.  n20 This Article posits that these problems reflect the inappropriate political influence that has corroded the public interest basis for financial regulation.

 [*510]  The foregoing discussion highlights the many needs of our modern economy with regard to financial regulation. First, regulatory policies must be determined through a process that maximizes the degree to which expertise may be brought to bear upon financial regulatory problems in order to respond to the challenges posed by globalization and increased complexity in financial markets. Second, regulation in this area must be able to respond to sudden changes in financial markets with rapid regulatory adjustments. Third, regulatory power must be centralized. Fourth, regulation of financial markets must be freed both of inappropriate political pressure and of inappropriate special interest influence. In short, financial market regulation presents a classic context in which an expert and independent agency is needed. Beyond this recognition, however, the questions that must be addressed are the degree of independence that is appropriate, and the legal structure needed to secure such independence.

This Article examines the degree to which depoliticizing financial market regulation can stem the problems discussed above. Financial market regulation is a vast subject matter; for purposes of this Article financial market regulation means the law of the capital markets of the United States. This Article attempts to articulate a theory of depoliticized regulation that can address the most obvious components of financial market regulation: the regulation of the public securities markets, as well as regulation of financial intermediaries such as banks, insurance companies, mutual funds, pension funds, and other financing institutions. Although presently there is no unified regulatory structure for these activities, this Article posits that there should be one. This Article demonstrates that the very fact that the regulatory system in this area has not been centralized is due to inappropriate and politically influenced regulation. Ultimately, this Article envisions centralized financial regulators with a great degree of political insulation. It is not possible, in the context of this Article, to review the history and failures of regulation in such a vast area. This Article searches instead for recurring patterns of regulatory failure in these areas, attempts to reach reasoned conclusions as to the causes of such failures, and articulates a proposed solution to these failures.

 [*511]  This Article recognizes that ultimately all law is political,  n21 particularly under the United States Constitution. Inappropriate political influence nevertheless can be minimized and nearly eliminated. In other words, the political nature of legal regulation is best thought of as a continuum, where on one end purely political regulation exists (exemplified best, perhaps, by the federal government's budget process), and on the opposite end is the regulation that is most free of political influence (exemplified by the Federal Reserve Board's administration of monetary policy). Part I explores agency independence, including an analysis of the maximum degree of insulation from political influence possible under the Constitution, and the problems of regulatory capture. Part II assesses the efficacy of depoliticized regulation, with a particular focus upon the Federal Reserve's management of monetary policy regulation. Part III reviews the recurring problems of the current political regime of financial regulation. Part IV articulates a proposal for imposing further depoliticized regulation in the vital area of financial market regulation. This Article concludes that any reforms of our financial market regulatory structure should include an aspirational goal of creating regulatory agencies endowed with a high degree of political independence.

 [*512]  I. AN ASSESSMENT OF AGENCY INDEPENDENCE AND DEPOLITICIZATION

Administrative agencies date to the beginning of the Republic. The first Congress passed three statutes conferring administrative powers.  n22 These agencies, like their modern counterparts, exercised adjudicative, legislative, and executive power.  n23 By the early part of the twentieth century, administrative agencies became a popular choice for addressing a wide variety of social problems.  n24 The Great Depression revealed serious deficiencies in the nation's economic structure and a number of agencies were created to address these shortcomings. Among these were the Securities and Exchange Commission (SEC), the National Labor Relations Board (NLRB), the Federal Deposit Insurance Corporation (FDIC), and the Social Security Board.  n25 In our federal system of government, the President, with the advice and consent of the Senate, appoints the officers operating these agencies who thus do not face election. The explosive growth of agencies in the last one hundred years represents, therefore, a transfer of power from elected officials to nonelected officials. More fundamentally, the delegation of massive regulatory power to administrative agencies that are not directly responsive to electoral politics represents an additional check on democratic lawmaking.  n26 Some commentators have recognized that the advent  [*513]  of such vast administrative power amounts to the creation of a "fourth branch" of government.  n27 Agencies can act with real independence from the executive and legislative branches only if endowed with a high degree of independence. Further, true independence from the executive and legislative branches depends upon many factors, including the breadth of the power delegated to the agency, its source of funding, its legal structure, and the degree of political commitment to the agency's independence.

At the height of the New Deal, the Supreme Court struck down delegations to agencies based on the principle that broad delegations of Article I power were not permissible.  n28 Modern decisions have held, however, that Congress can delegate legislative power to administrative agencies and insulate those agencies from the "political winds that sweep Washington."  n29 There are theoretical limits to the extent of such delegations. The Supreme Court has long held that Congress may delegate legislative power, without offending the constitutional requirement that Congress hold the legislative power of the federal government, as long as Congress provides intelligible principles to guide the agency in exercising delegated power.  n30 Indeed, it has  [*514]  been sixty years since the Court last struck down legislative delegations, even though Congress often employs vague and sweeping delegations to achieve its goals.  n31 Moreover, those decisions that have stricken delegations often involved delegation in its "most obnoxious form" -- the administration of government powers by private actors.  n32 Similarly, the delegation doctrine has also continued to operate as a rule of statutory construction, allowing the Court to interpret narrowly those delegations that may raise issues of excessive delegation.  n33 Even in its most historically virulent form, the delegation doctrine has not operated to strike down delegations to government agencies of broad powers accompanied by reasonably specific articulations of policies and standards.  n34 In short, the Constitution permits broad delegations of authority to administrative agencies.

The Constitution also limits the structural independence of administrative agencies so as to avoid the creation of a despotic agency without any political accountability or control. The Appointments Clause of Article II requires that the President appoint  [*515]  all "Officers of the United States" with the advice and consent of the Senate, and that "inferior Officers" be appointed by the President, courts of law, or heads of departments.  n35 The President also retains supervisory authority to remove such officers, if those officials owe duties that may be characterized as essential to the discharge of the President's duties.  n36 These officials must be removable at will in order for the President to execute Article II powers.  n37 Nevertheless, though it is true that the heads of executive agencies, such as cabinet departments, serve at the pleasure of the President, the heads of independent agencies, typically commissioners or board members, may be removed only for "good cause," and may serve a fixed term.  n38 Congress has provided the terms for commissioners that range between five and fourteen years.  n39

The creation of "independent" agencies has not been without controversy. Many have argued that "independent" agencies are unconstitutional because they exercise power without being subject to presidential control.  n40 In Bowsher v. Synar,  n41 Chief Justice Burger authored a draft opinion that would have held that any agency officer charged with the execution of law must  [*516]  be subject to removal solely by the President.  n42 Certainly, this could have led to a challenge to the constitutionality of independent commissions. This same approach also has emerged in the opinions of Justice Scalia, such as his dissent in Morrison v. Olson.  n43 According to Justice Scalia, the Constitution requires that all executive power be vested in the President.  n44 This means the President must have "exclusive" control over all "executive" power.  n45 Notwithstanding these reservations, it now appears well-settled that Congress may create agencies that are independent of executive control to the extent the President may remove its officers only for "good cause," so long as the removal restriction does not "impede the President's ability to perform his constitutional duty."  n46 In fact, many Justices appear deeply committed to the institution of independent agencies.  n47 At oral argument in Bowsher, when the government accused the petitioners of fear-mongering on the issue of the viability of independent commissions, Justice O'Connor replied: "They scared me."  n48 Over the decades, independent commissions have endured challenge after challenge on grounds similar to those asserted in Morrison.  n49 This leaves Congress with broad latitude to form agencies with independence from the executive.

Congress also controls agencies through its control of appropriations. Nearly all agencies depend upon annual congressional funding.  n50 There are some government-owned or government-sponsored  [*517]  organizations that are not subject to presidential or congressional budgetary review.  n51 These organizations, however, are not generally regulatory agencies.  n52 Commentators maintain that control over an agency's budget and appropriations renders any distinction between independent agencies and executive agencies meaningless.  n53 Naturally, an agency beholden to either the executive or the legislature hardly can ignore the wishes of the politicians or their influential constituents. Additionally, members of Congress often attach limits on agency discretion to appropriations bills.  n54 Thus, any assessment of an agency's independence must include an analysis of the degree to which it is subject to the power of the purse.  n55 Given the importance of an agency's financing in terms of its actual political independence, it is surprising that most proposals for regulatory reform have not focused on this element of an agency's legal structure.  n56

The legal structure of an agency is only part of the agency's political independence. No matter how independent an agency may appear based upon a cold legal analysis, ultimately the political branches have the power to restructure the agency,  [*518]  abolish the agency or otherwise limit its independence. Independence turns, therefore, not only upon the agency's structure, but also upon the strength of presidential and congressional commitment to its independence. Although it is true that Congress creates administrative agencies in part to remove specified areas of regulation from such pressures, this does not mean that all agencies operate free from such pressures.  n57 Typically, regulatory agencies are subject to a number of informal pressures from Congress.  n58 Congress can limit an agency's jurisdiction, cut off its appropriations, or ruin a regulator's career. These levers mean that Congress informally can curtail agency independence even without legislating.  n59 Consequently, agencies are responsive to congressional interests. Similarly, no agency would wish to incur the wrath of the President. In short, political independence depends upon political commitment to an agency's independence which in turn is dependent upon traditional, bipartisan support for the agency, its reputation, and the strength of the consensus supporting independence.

Thus, the degree of political independence of an agency can be determined by considering: (1) the breadth of its delegation; (2) the extent to which its governing body can be removed by the President; (3) the terms of the members of its governing body, especially its Chair; (4) the method of funding the agency; and (5) the degree to which the agency enjoys bipartisan, long-term political commitment to its independence. This is a more complete approach to agency independence than others that have traditionally focused upon the President's removal power. This multifactored assessment of political independence recognizes, for example, that an agency with a broader delegation of power is more insulated from judicial review and less prone to regulatory competition than an agency with narrower delegation. This Article proceeds from the position that a multifactored approach  [*519]  to independence provides a fuller explanation of agency action, and serves as the foundation for determining the ability of an agency to resist political pressure and special interest influence.

Why would Congress ever wish to create entities with lawmaking authority that are beyond its direct control? The reasons are both familiar and subtle. First, "delegations take lawmaking out of a region of representative government and into a zone of government by specialists presumed to act according to more disinterested and scientific judgments of good social policy."  n60 Second, delegation to agencies "makes possible a greater range and volume of lawmaking" through the administrative regulation process.  n61 Third, Congress may seek to set up agencies specifically designed to circumvent problems posed by excessive political influence, either to stem the influence or to allow an agency to resolve an issue mired in gridlock.  n62 Fourth, Congress may seek to pass laws regulating specific areas but recognize that political regulation may be unsaleable politically.  n63 Each of these factors explains why Congress endows a given agency with a certain degree of independence.  n64 In essence, the determination of the degree of independence should turn upon congressional recognition of its own institutional limitations to govern regulation in a given area.

Some commentators hypothesize that power is ceded when legislators determine they can extract increased rents by divorcing  [*520]  power from Congress.  n65 Such a cynical view of congressional behavior ignores the fact that administrative delegations seem positively correlated to exogenous economic disruptions.  n66 The possibility that Congress sometimes acts specifically out of a desire to enact good policy should not be ignored completely.  n67 Congressional representatives, like humanity in general, are not capable of always acting as "rational maximizers," but are capable of subjugating their immediate self-interest to a greater good; in short, Congress can act in accordance with the public interest.  n68 A more likely conclusion is that many different motivations coalesce to cause Congress to part with power.  n69 Either way, Congress does not tend to cede legislative power unless there is a compelling case for doing so.

The original policy basis for independent agencies, therefore, was that they would: (1) professionalize and provide expertise to regulatory policy; (2) provide a stable and consistent basis for regulatory continuity; (3) allow for constant regulatory adaptation to changing conditions; and (4) eliminate the political influence of special interests.  n70 Beginning in 1887, with the formation of the Interstate Commerce Commission, and culminating in the  [*521]  Progressive Movement of the early twentieth century and the New Deal, Congress began minting independent agencies to attack a wide array of ills.  n71

By midcentury, however, commentators began to question whether independent agencies could deliver upon their promises. Moreover, there has been growing cynicism among scholars about whether regulatory agencies can ever function in the public interest.  n72 These scholars have catalogued the sources of pressure acting upon regulators that prevent agencies from vindicating the public interest. One commentator has observed that independence from the executive may isolate an agency from sources of political strength within the executive branch, and allow the agency to be molded into "a friendly protector of private interests rather than an aggressive agent of the public welfare,"  n73 and a means to provide "regulated groups with privileged access to government."  n74 In other words, the regulated can capture the regulators through the co-opting of career-minded or budget-maximizing bureaucrats and fund-raising legislators focused perpetually upon the next election.  n75 Similarly, Congress, subject to re-election in biannual elections, is quite sensitive to campaign contributions, other forms of campaign support, patronage, and even outright bribes.  n76 Congress, in turn, can exert pressure over administrative agencies, which must appear before Congress annually to obtain its budget approval.  n77 Commentators also have recognized the high degree of social pressure that can be exerted upon regulatory agencies, ranging from prospective employment to social functions.  n78

By the 1970s, economists, political scientists, and legal scholars were debating which theories best explained the domination of regulation by special interests.  n79 More recently, scholars have  [*522]  expanded the theory of capture beyond administrative agencies to policy-making organs generally, and have de-emphasized the role of "monied interests." They recognize instead the general power of special interests to act as advocacy coalitions.  n80 Thus, there has been a growing consensus over the years that regulation is often highjacked, at least to some extent, from serving the general public interest to serving special private interests.  n81 Perhaps the question that should be posed is not whether socalled independent agencies are subject to capture (they are), but whether there exists a threshold of independence beyond which an agency is highly resistant to capture.  n82

The Federal Reserve Board (the Fed) is an example of just how politically independent an agency may be, particularly in the area of monetary policy.  n83 Congress created the Fed pursuant  [*523]  to the Federal Reserve Act of 1913,  n84 in the wake of the catastrophic Panic of 1907.  n85 The Fed administers the Federal Reserve System,  n86 which is responsible for maintaining an "elastic currency," acting as a lender of last resort for the banking system and discounting commercial paper.  n87 It is difficult to conceive of an administrative agency with more power and more political independence than the Fed.  n88 Indeed, the Fed has the power to issue currency without limitation.  n89 Although certain agencies have enjoyed a high degree of political insulation at times, rarely have agencies enjoyed a long-term consensus that they should operate free of political influence. For example, the Legal Services Corporation has alternated between being a political punching bag and enjoying political insulation.  n90

The Fed enjoys both a depoliticized structure and a long-term commitment from the political branches to its continued independence.  n91 The President, with the advice and consent of the Senate, appoints Fed members to fourteen-year terms and they  [*524]  are removable only for cause.  n92 The chairman of the Fed is appointed for a four-year term.  n93 The Fed members' terms are staggered so that one of the seven members' terms expires every two years.  n94 Thus, a president who serves only a single term may have only two members they may appoint. The length of terms for both Fed members and the chairman are the longest terms enjoyed by any agency.  n95 The Fed governors also enjoy competitive salaries for public servants; as of 1994, governors earned $ 123,100 annually and the chairman earned $ 133,600 annually.  n96 In addition, governors are prohibited from serving in the banking industry for two years after exiting the Fed if they fail to complete their entire fourteen-year term.  n97 All of this means that the Fed is the beneficiary of a high degree of structural independence.

Originally, the Secretary of the Treasury and the Comptroller of the Currency, both executive officers, served on the Fed, but the Banking Act of 1935  n98 terminated their membership.  n99 The Banking Act of 1935 also increased the tenure of the Fed governors from twelve to fourteen years,  n100 and centralized further the control of monetary policy in the Board.  n101 The purpose of the Banking Act was to endow the Fed with more political insulation so that it could exercise its control over monetary policy in a way that represented the "general public interest" and did not operate in accordance with "a majority of special interests."  n102 The Banking Act was an essential part of President Roosevelt's economic recovery plan and he intervened personally to assure its passage.  n103 The Banking Act represents the commencement of the Fed's modern existence in that the Banking Act definitively  [*525]  vested monetary policy in the Fed and assured that it was endowed with a high degree of independence.

The Fed is also remarkably independent of the appropriations process. The Fed has the power to assess member banks to supply funds for its operating expenses.  n104 In 1933 Congress declared these funds not to be "government funds or appropriated moneys."  n105 As a result, the expenditure of these funds is essentially free of congressional oversight.  n106 Similarly, the Fed has the power to determine freely the compensation of its employees without being restricted by government service pay scales.  n107 All of this insulation from political influence has prompted Professor Aman to state that the Fed is "one of the most powerful and independent federal agencies engaged in economic regulation."  n108 This may be somewhat of an understatement; the Fed is the only regulatory agency that is totally self-funded and free from the appropriations process.  n109 Occasionally the Fed has been subject to government budgetary oversight and audit, but the general rule is that it need not annually submit its budget to Congress for approval.  n110

The Fed is required to make certain reports regarding its activities, including an annual report of its operations to the  [*526]  Speaker of the House.  n111 The Fed also must report every sixty months to Congress on the availability of credit to small businesses.  n112 The Fed must keep records of its determinations regarding monetary policy and must disclose these records to Congress.  n113 The most celebrated Fed disclosure is the Chairman's semiannual testimony on economic conditions pursuant to the Full Employment and Balanced Growth Act of 1978.  n114 Although these reporting requirements may well increase the political accountability of the Fed, they hardly represent a substantial check upon the Fed's control of monetary policy.

The Fed also has been delegated broad, almost unlimited, power over monetary policy.  n115 The Fed has three tools giving it tight control over the nation's money supply. It has great influence over short-term interest rates by virtue of its control over the discount rate  n116 and the federal funds rate.  n117 The discount rate is the interest rate the Fed charges depository institutions that wish to borrow from it; consequently the Fed directly influences the cost of money for a depository institution.  n118 The Fed also has the power to accelerate or decelerate the money creating credit process of the commercial banking industry due to its control over reserve requirements.  n119 The Fed also controls the Federal Open Market Committee which expands or contracts the money supply by buying or selling government bonds.  n120 With its  [*527]  tight control over the money supply, the Fed may well be the most powerful economic actor, domestically and internationally.

In the last few decades, economists have increasingly recognized the dominance of monetary policy in influencing economic output.  n121 The guidance from Congress on the goals the Fed should achieve in administering monetary policy are so general as to be essentially devoid of meaning in practice, requiring the Fed to maximize output and maintain price stability.  n122 Economists generally have recognized that the Fed is so powerful that its policies can dictate whether the general economy expands or contracts.  n123 In other words, the Fed can induce recessions that cut incomes and cost jobs or induce economic expansions that increase incomes and employment.  n124 Increasingly, the Fed not only holds sway over domestic economic conditions, but also over global economic conditions.  n125 Thus, the Fed has been endowed with both vast powers and the highest degree of political insulation.

Of course, political independence explains only a part of an agency's accountability. The judiciary reviews a wide array of  [*528]  agency decisions. The judiciary will not allow agencies to take action that is contrary to their governing statutes. The courts also will ensure that agencies adhere to concepts of due process. Within these broad limitations agencies largely operate with little judicial interference.  n126 Indeed, certain areas of agency action essentially are nonreviewable because of prudential limitations the judiciary has imposed upon itself, such as standing limitations.  n127 For example, the Fed's power over monetary policy probably is not reviewable because these decisions are committed to the agency's discretion  n128 and it is unlikely that any particular person could establish any statutory "core of interests" intended for protection.  n129 The courts thus far have refused to extend jurisdiction to any purported victim of the Fed's policy.  n130 Similarly, the Fed has exempted itself from the rule-making provisions of the Administrative Procedure Act (APA)  n131 with regard to its control over monetary policy.  n132 With its very broad delegation, the Fed operates virtually free of judicial restraint in conducting monetary policy.  n133

In the final analysis, the Fed is only as independent of political influence as the politicians permit.  n134 The Fed enjoys the  [*529]  highest degree of commitment to its political independence. Presidents from Eisenhower  n135 to Carter have publicly affirmed their commitment to the Fed's independence.  n136 The current administration is also committed to the Fed's continued independence.  n137 Treasury secretaries have defended the independence of the Fed.  n138 The Fed is aware that Congress can revoke its independence or narrow its powers at any time. Consequently, the Fed exercises its independence with a sensitivity to this ultimate vulnerability. The Fed is particularly vulnerable because of its vast power and its perceived lack of accountability.  n139 Nevertheless, Congress has neither the incentive nor the institutional capability for monitoring the Fed. Monetary policy is too complicated and risky to encourage congressional interference with the Fed.  n140

Over the years, the Fed appears to have acted, at times, to foil political initiatives when economic policy so demanded.  n141 Still,  [*530]  the Fed has also taken great pains to avoid influencing elections.  n142 As a consequence, the Fed has avoided any significant political initiative to constrain its power or restrict its independence. The Fed's success at this balancing act has served as a major prop to its independence. Another prop to Fed independence is the financial community's belief that Fed independence is crucial to a sound currency and emblematic of the government's commitment to fighting inflation.  n143 In the area of financial market regulation, the Fed has achieved a remarkable level of political independence.  n144 A key element of the Fed's independence, both as a matter of legal structure and political commitment, is the strength of the policy basis of its independence.  n145

The reasons why Congress created the Fed and endowed it with such extraordinary independence and power seem clear. The primary reason given for the Federal Reserve Act of 1913 was to "furnish an elastic currency."  n146 Although modern economic theory associates money supply manipulation to monetary policy, in 1913 an "elastic currency" referred to a more basic economic need.  n147 Specifically, Congress was far more concerned with "seasonal" currency needs and the mobility of reserves (or liquidity) to meet the cyclical agricultural demand for money.  n148  [*531]  These seasonal disruptions in currency demand caused panics and bank runs that, in turn, triggered severe economic contractions in 1907, 1896, 1893, 1890, 1884, and 1873.  n149 These panics had increased the saliency of banking law reform in the public's political consciousness. The Democratic Party, for example, included a provision in its 1912 platform for banking law reform designed to relieve currency shortages.  n150 By the time of the passage of the Banking Act of 1935, Congress explicitly understood the relationship between money supply and output, and reconceived the Fed's role from mere currency "accommodation" to protector of "business stability."  n151 The independence Congress extended to the Fed must be viewed as a recognition of the dangers of political influence over monetary policy. Commentators have long demonstrated that politicians face an irresistible urge to inflate currencies for political gain.  n152

Even though the full impact of the Fed's control of monetary policy as a means of determining macroeconomic output was not fully appreciated in 1913, the power granted to the Fed was still vast. The Fed could print money.  n153 In 1913, the backing of the currency was a hot political issue;  n154 thus, the granting of this power to the Fed demonstrates that Congress consciously understood that the "independent" agency it was creating would wield tremendous power.  n155 Yet, Congress still endowed the Fed with tremendous independence. The Federal Reserve Act of 1913 is nothing less than a reaffirmation of the suspicions of unbridled democracy that lie at the foundation of our constitutional system. In the context of the power to create money, the 1913 Act  [*532]  evinces a deep-seated suspicion that invariably politicians would manipulate the money supply and debase the currency in an effort to assure re-election. Simply put, Congress decided that the political process could not be trusted with the power to print money in a modern economy.  n156 Consequently, the Fed was, as Senator Carter Glass, a chief sponsor of the Act, stated during the Act's debates, "'to be wholly divorced from politics.'"  n157 This desire for depoliticizing monetary policy reflects the strength of the policy basis of the Fed, and hence the strength of the political commitment to its independence.

The independence of the Fed should be contrasted with the "independence" of other financial regulators.  n158 For example, the SEC is governed by a regulatory commission, which is appointed by the President for five-year terms and must have a bipartisan composition.  n159 Nevertheless, SEC commissioners serve at the pleasure of the President.  n160 Moreover, the SEC is not funded independently and must go to Congress for its annual appropriation.  n161 Consequently, the SEC has been subject to significant legislative incursions upon matters that were putatively left to its discretion. For example, Congress occasionally has pressured the SEC to alter its disclosure rules.  n162 Recently, Congress  [*533]  also invaded the SEC's discretion to define securities fraud.  n163 Indeed, in the 1999 appropriation bill funding the SEC, Congress included a significant amendment to the securities laws: specifically, the Securities Litigation Uniform Standards Act of 1998 (the Uniform Act).  n164 Traditionally, the federal securities laws provided remedies to investors that were cumulative of state law remedies.  n165 This meant that the federal securities laws could only operate to extend increased protection to investors. The Uniform Act, however, preempts state law with regard to securities litigation involving publicly traded companies. Combined with the Private Securities Litigation Reform Act of 1995 (PSLRA),  n166 the Uniform Act means that the federal securities laws now operate to restrict investor remedies only.  n167 Initially, the SEC did not support the Uniform Act.  n168 Those who argue that all protective regulation is turned invariably to the advantage of the regulated would not be surprised with this result.  n169  [*534]  The New Dealers who led the charge to federalize investor protection would be horrified.  n170

Even if agencies like the SEC enjoyed the same structural and institutional independence as the Fed, they would remain vulnerable to capture because their power is highly fragmented. For example, regulatory experts recognized as early as 1949 that the fact that regulatory power was splintered among numerous federal agencies and shared with each of the states undermined the federal program of bank regulation.  n171 The Hoover Commission recognized that this allowed banks to play supervisory authorities against each other and that banks could escape regulatory mandates by choosing their regulator.  n172 Consequently, these agencies do not have the same ability to make decisions free of political influence. They must pay heed to the regulated or lose the ability to exercise significant regulatory power. When a regulated industry has the ability to choose their regulator, a giant channel towards capture is opened. There is no similar regulatory competition in the area of regulating monetary policy. Thus, except for the Fed's control of monetary policy, financial regulation is prone to the same shortcomings of politicized regulation that are pervasive in the modern regulatory state.  n173

Recently, scholars in the area of administrative regulation, led by Justice Stephen Breyer, have argued that depoliticization of administrative regulation can be used to address problems inherent in the regulatory process.  n174 Justice Breyer argues that  [*535]  three fundamental problems infect agency regulation. First, the public is subject to various forms of cognitive dissonance which results in a failure to rationally weigh costs and benefits of various regulatory programs.  n175 It would not surprise anyone, for example, that ordinary citizens, preoccupied with family obligations, social relationships, full-time employment, financial challenges, saving for retirement and college, and faced with a vast array of information and intellectual attractions, ranging from the existence and meaning of black holes to whether the President had sex with a young intern, may not always have the time or resources to determine which environmental risks, for example, are the greatest.  n176 Second, Congress, in responding to political pressures, necessarily transmits poor public perception, combined with its own institutional infirmities, into law.  n177 Breyer highlights the fact that Congress enacts one statute at a time and often fails to look at problems in a unified fashion across overlapping committee jurisdictions.  n178 Third, administrative agencies, necessarily acting in an environment of great uncertainty, and with competing agendas and constituencies, often take inconsistent approaches to similar problems, resulting in uncoordinated regulation.  n179 This vicious circle creates misregulation plagued by tunnel vision, irrational agendas, and inconsistency.  n180  [*536]  In short, Justice Breyer has identified a series of malfunctions in agency regulation generally that are not dissimilar to the problems that other scholars contend generally plague regulation -- all resulting from too much political influence in the agency process.  n181

Justice Breyer's articulation of the problems of regulation focuses on issues endemic to environmental risk regulation. The scope of his solution is, however, without any such limitation. Justice Breyer posits that "[a] depoliticized regulatory process might produce better results."  n182 Breyer argues for the creation of a group with interagency jurisdiction and political insulation to coordinate and rationalize regulation.  n183 This group would have authority to impose its decisions and would have the power to build a coherent risk-regulating system adaptable across agencies.  n184 These "superregulators" would be chosen from a specific career path that would add their expertise to regulation and be given civil service protection.  n185 The career path would require service in Congress, the Office of Management and Budget, and administrative agencies.  n186

Certainly, Justice Breyer's proposal has generated criticism.  n187 Not the least of these is that such a proposal tends toward an undemocratic, elitist government.  n188 Critics have already launched  [*537]  such attacks upon the current regulatory structure, even without a group of superregulators with civil service protection and insulation.  n189 No doubt, these critics are correct that depoliticizing regulation and delegating power to administrative agencies lessens democratic influence, often over important areas of our society. Nevertheless, in appropriate circumstances such depoliticization and delegation is both consistent with, and supportive of, the American republican tradition. Specifically, American government has always been designed both to limit and to accommodate democratic influences.  n190 From the beginning of the Republic, certain issues were not a matter of politics. The Founders specifically contemplated a depoliticized system of legal regulation.  n191 Thus, the President serves a four-year term, subject only to the drastic remedy of impeachment, and Senators serve six-year terms.  n192 Article III judges enjoy tenure during "good behavior."  n193 American citizens, in fact, elect leaders; so long as these leaders are accountable to voters for all of their policy decisions, including their supervision of agencies, delegation cannot be termed antidemocratic, in any traditional sense.  n194 Thus, the question really should be not whether Justice  [*538]  Breyer's proposal for depoliticization is undemocratic, but whether broader depoliticization is possible without the constitutionally dubious excesses of Justice Breyer's proposal. This Article responds affirmatively to that inquiry.

As society has become more complex, and many legal issues consequently demand a higher degree of expertise, the ability of the electorate to make informed decisions is compromised. Rapid evolution in specific areas of legal regulation compromises the ability of even a republican form of government to respond. Political scientists as well as legal scholars have recognized the pernicious effects upon sound regulation that follow from these realities.  n195 Under these circumstances, placing issues of low political saliency before a traditional regulatory agency can invite special interests to obtain regulatory largess. Congress, on the other hand, often lacks sufficient institutional expertise and flexibility to manage certain areas of government activities.  n196 Moreover, Congress itself is often prone to distributing largess. With these realities in mind, the next Part demonstrates that circumstances can exist to render depoliticized regulation, in accordance with the Constitution, an effective means to support our democratic government -- by taking areas of low political visibility, and shedding the light of uncorrupted expertise upon them.

II. AN ASSESSMENT OF DEPOLITICIZED REGULATION

This Part assesses the success of depoliticized regulation, with a specific focus on the Fed. As demonstrated above, the Fed is endowed with a high degree of independence from the political process.  n197 The emphasis of this Part is an attempt to determine  [*539]  whether depoliticized regulation delivers upon its promise of a sounder basis for regulation. This discussion does not focus on the Fed's use of this power and independence to discharge its economic objectives.  n198 Economists have long debated, for example, whether the Fed should focus on setting economic aggregates, interest rates or money stocks, and politicians have debated the relative value of stemming unemployment or inflation.  n199 Instead, this discussion focuses on the success of the Fed in conducting monetary policy free of political influence. This Part also assesses whether the putative benefits of depoliticization have been realized.

The Fed's authority over monetary policy is somewhat accidental.  n200 After the Panic of 1907, many believed that an elastic currency was needed to stem bank runs and provide liquidity for  [*540]  the financial system.  n201 Certainly, the Fed has power over the nation's money supply,  n202 but this was not the main point of the Act.  n203 The link between aggregate output and monetary policy was not fully understood in 1913; indeed, it was not until after World War II that monetary policy was fully appreciated.  n204 At the time of the Federal Reserve Act, the Fed actually was considered a "collection of supercorrespondent banks," rather than a key economic policymaker.  n205 There is no mention in the legislative reports accompanying the Act of the Fed's responsibility for monetary policy and, similarly, no mention of the Fed having the power to determine output, prices, and growth.  n206 Congress did not predict in 1913 just how powerful its creature would become.  n207 Nevertheless, Congress did knowingly endow the Fed with unparalleled power and independence.  n208 The Banking Act of 1935, and to a lesser extent other New Deal adjustments to the nation's regulatory structure, represents a conscious decision by lawmakers to expand the Fed's power and independence.  n209 Congress took these steps at a time when issues of financial reform were at the forefront of public debate.  n210 Ultimately then, the Fed's independence is a reflection of a political determination that the Fed should have vast power that could be exercised free of political influence.

The Fed in its infancy hardly appreciated its economic power. Indeed, the modern Fed really did not exist until 1935.  n211 Shortly after 1935, the Fed seems to have botched its economic responsibilities and engineered the premature death of an otherwise promising recovery from the Great Depression in 1937.  n212 Thereafter,  [*541]  the Fed adopted a policy of almost total passivity until after World War II.  n213 Thus, through World War II and the period immediately thereafter, the Fed generated little or no political controversy.  n214 It was not until about 1950 that the Fed really began to exercise its monetary policy might.  n215 The present analysis is primarily concerned with the period after 1950; however, it is significant that in its detailed analysis of independent regulatory agencies, the Hoover Commission in 1949 singled out the Fed for its "many excellencies" in discharging its regulatory obligations, particularly in its management of monetary policy.  n216

In 1950 the Fed had its first significant policy differences with the executive branch. After the start of the Korean War, the Fed wanted to pursue a restrictive monetary policy to control an expanding economy.  n217 The Treasury Department desired lower interest rates so that it could manage its wartime debt less expensively.  n218 President Truman stepped in to moderate the conflict. Apparently, Truman sided with the Fed, and on March 4, 1951, the agencies executed the Treasury-Federal Reserve Accord, which recognized that ultimate authority for monetary policy rested with the Fed.  n219 Although this accord was a mutual promise of cooperation, it became a declaration of independence for the Fed because it explicitly recognized that the Fed had discretion to monetize the debt by issuing Federal Reserve Notes in exchange for bonds or to allow increased government borrowing to increase interest rates.  n220 The fact that Truman did not push the administration's position and allowed the Fed to maintain its independence with respect to monetary policy was a significant step in assuring the political independence of the Fed.  n221 Those economists who have attempted to quantify central  [*542]  bank independence focus specifically upon the central bank's ability to set monetary policy free from the government's need to finance operations.  n222 On this score, the Fed rates high marks. After the 1951 agreement, the Fed had the power to conduct monetary policy free from the executive's fiscal policy.

The question of whether banking interests, or other special interests, have captured Fed monetary policy is somewhat more complicated.  n223 Banks are a "transmission belt" of the Fed's monetary policy.  n224 The Fed can manipulate monetary conditions, but it cannot force banks to lend or to lend at specified rates.  n225 Particularly with respect to long-term lending rates, the Fed is at the mercy of the banking industry's inflationary expectations and confidence in business conditions.  n226 The Fed must, therefore, maintain the confidence of the banking industry.  n227 Congress has recognized this need from the beginning of the Federal Reserve System by providing for the creation of the Federal Advisory Council (FAC).  n228 The FAC consists of powerful banking  [*543]  interests that are granted privileged access to the Fed through regular, formal meetings.  n229 Scholars studying the minutes of these meetings have concluded that the Fed dominates the sessions and uses them to obtain important information from the banking industry; thus, these scholars have concluded that the Fed is not controlled by the FAC.  n230

Often, the FAC has been an unmitigated failure in seeking to influence Fed policy. In the late 1970s, the FAC complained that the Fed's refusal to pay interest on the reserves maintained by member banks with the Federal Reserve System constituted a discriminatory tax upon members.  n231 Congress, at the Fed's urging, responded by requiring all banks to keep interest-free balances with the Fed.  n232 The Fed seems to use the FAC to gather important information and influence bank industry conduct.  n233 The FAC is perhaps best viewed then as an institutional mandate to consider information obtained from the banking industry in making decisions regarding monetary policy. This institutional mandate may be mistaken for obsequious behavior by a regulator beholden to the industry it regulates.  n234 Nevertheless, nearly all observers agree that the banking industry does not control the Fed's monetary policy machinery, and that the Fed regularly undertakes monetary initiatives that are contrary to the shortterm interests of the banking industry it regulates.  n235

 [*544]  For example, in October of 1979 the Fed determined that interest rates needed to rise rapidly.  n236 As a politically attractive means of achieving this, the Fed began to target monetary aggregates instead of interest rates, which in turn increased interest rate volatility, at least in the short-term.  n237 Understandably, banks, as lenders, would like stable interest rates.  n238 Targeting monetary aggregates instead of a given interest rate level naturally leads to increased interest rate volatility. There is little doubt that this increased interest rate volatility hurt the banking industry, as the relative value of outstanding loans declined and commercial banks lost deposits to relatively more attractive money market mutual funds.  n239 Such instances of demonstrable harm to the banking industry in the name of economic stability are inconsistent with any theory of monetary policy capture.  n240

In fact, on a general basis, banks prefer prosperity. With prosperity the demand for loans increases and bank balances expand. Rates of default decline, and banks can make money even on many imprudent loans. When the Fed undertakes a restrictive monetary policy these conditions do not prevail, and in an extreme recession even sound loans can lead to losses.  n241 Any time the Fed tightens money, therefore, the banking industry suffers. Yet, the Fed has undertaken several rounds of very restrictive monetary policy in recent decades.  n242 Thus, at least with respect to the Fed's administration of monetary policy, there is strong evidence that the Fed's powers have not been "captured."

As mentioned above, unlike agencies that suffer from persistent problems of regulatory competition, the Fed enjoys a regulatory  [*545]  monopoly over the administration of monetary policy. Congress has, in fact, jealously guarded the Fed's turf.  n243 For example, in the late 1970s the Fed began to lose members. As interest rates rose, the cost of maintaining interest-free reserves at the Fed increased. By early 1980, Chairman Volcker testified to Congress that the Fed was in danger of losing full control of monetary policy because Fed membership was in danger of dropping to below sixty percent of the banking industry.  n244 Congress responded quickly.  n245 In 1980, it required that all depository institutions adhere to Fed-dictated reserve requirements and report to the Fed.  n246 Congress thus demonstrated its commitment to the Fed and the Fed's exclusive control over monetary policy, giving the Fed no need to consider the policies of any regulatory competitor.  n247

Of course, the banking industry can always lobby the President or Congress, even if it cannot directly influence the Fed. This raises the issue of whether the Fed truly is independent of the political branches. Before this issue can be properly assessed, however, independence must be considered in context. Specifically, no commentator seriously believes that the Fed should be completely independent of elected leaders, even if our constitutional system permitted such a structure.  n248 Such unbridled power is utterly inconsistent with our republican tradition. Instead, independence must be considered on a relative basis. Some political accountability is both desirable and mandated by the Constitution.  n249 Given its functions, the Fed appears ideally independent.  n250 The Fed can defy powerful politicians, but is also  [*546]  aware that ultimately it must be accountable to the will of the people.  n251

As mentioned above, over the years both legislators and presidents have made strong statements endorsing the Fed's political independence. One commentator has stated: "few members of Congress really want to control monetary policy."  n252 This reflects several facts. First, Congress understands fully its own institutional limitations in managing monetary policy. Congress has neither the time nor the dexterity to really control monetary policy.  n253 Indeed, it could be disastrous if monetary policy became locked up in Congress due to competing power coalitions. Second, there appears to be strong consensus among influential policymakers that monetary policy must be administered free from special interest influence.  n254 Politicians, no doubt, also have appreciated the political cover that comes with having the Fed as a scapegoat for economic disruptions. There is broad consensus that all of this amounts to a strong bipartisan commitment to the Fed's independence.  n255

This does not mean that the Fed does not have conflicts with the President or Congress. On the contrary, the Fed constantly is subject to political conflict, and thereby subject to political pressure. For example, in 1979 the Fed dramatically tightened  [*547]  money at the beginning of the presidential election cycle.  n256 On August 16, 1979, seven days after Chairman Paul Volcker was sworn in, the Fed raised the discount rate to an all-time high of 10.5%.  n257 Then, in October of 1979, the Fed became serious about fighting inflation and allowed key short-term rates to climb to eighteen percent.  n258 In March of 1980, the Fed even went so far as to impose credit controls.  n259 In mid-1980, the economy suffered a severe recession, as the gross national product shrank by ten percent, the sharpest contraction in thirty-five years.  n260 Jimmy Carter lost the election of 1980 and key supporters attributed the defeat, at least in part, to the Fed's tight money policies.  n261

President Carter attacked the Fed's policies but never attacked the Fed's independence.  n262 Carter likened the Fed's independence to the independence of the judiciary.  n263 Thus, as the election slipped away, the President of the United States was reduced to telling voters, that although he disagreed with the Fed's policy, he had no influence over it.  n264 The Fed had allowed a sitting President to perish upon the battleground of monetary policy.  n265 Even more impressive is that Chairman Volcker acted with such monetary restraint just a short time after President Carter appointed him to his post with the Fed.  n266 For the most  [*548]  part, the Fed's tightening had occurred despite objections from the Carter White House.  n267 The Fed had successfully resisted political pressure and instead tamed inflation.  n268

Another example of the Fed's ability to defy even Presidents occurred during the Reagan Administration. Shortly after the 1980 election the administration announced $ 540 billion in tax cuts.  n269 Simultaneously, the administration announced hundreds of billions in defense spending increases.  n270 Fed Chairman Volcker concluded: "'There is no way we can avoid a clash between monetary restraint . . . and the growth of economic activity.'"  n271 In other words, Volcker was signaling his intent to counter any fiscal stimulus with tighter monetary policy. Soon enough, the Fed allowed short-term rates to reach as high as 20.5%.  n272 The Fed even went so far as to lobby members of Congress against the President's tax cut program.  n273 Unemployment soared as twelve million Americans were out of work.  n274 The gross national product declined sharply.  n275

With constituents starting to feel real pain, and with the 1982 elections fast approaching, both political branches undertook  [*549]  initiatives striking at the heart of the Fed's independence. James Baker, the White House Chief of Staff, began to lobby the Fed for a more expansionary monetary policy.  n276 At the same time, Treasury Secretary Donald Regan proposed that the Fed become a subagency of the Treasury Department, directly accountable to the President.  n277 Congressional efforts to strip the Fed of power ranged from forcing the Fed to abandon its reliance upon monetary aggregates to a congressional resolution commanding the Fed to reevaluate its monetary policy.  n278 Significantly, financial interests did not react favorably to suggestions that the Fed be stripped of independence.  n279 Despite real concern about its institutional independence, the Fed held monetary policy tight and resisted the highest degree of challenge to its institutional independence.  n280 The Fed had scored a major political victory.  n281 It had again fulfilled its basic mission to forsake political pressures and constrict growth to stem inflation.  n282

 [*550]  This is not to say that the Fed is never subject to political influence. The Fed, under Chairman Arthur Burns, has been subject to controversial allegations that it specifically manipulated monetary policy in order to influence the election of 1972.  n283 There is also strong evidence that the Fed allows its desire to avoid the appearance that it is manipulating monetary policy to influence elections, to cause it to refrain from policy steps it otherwise may take.  n284 These concerns do not subvert the thesis of this Article. First, this Article fully recognizes that under the Constitution no lawmaking actor can be immune from political pressure. Second, this Article argues that some political responsiveness is a good thing; that is, an agency with no degree of political responsiveness would likely cease to exist.  n285 Third, it is fully consonant with the Fed's mission to guard jealously its independence, even if this requires the Fed to play politics.  n286 Finally, a politically ambitious Fed chairman probably could influence monetary policy based upon inappropriate political pressure. The question, however, is simply whether the Fed is sufficiently independent that it can resist political pressure. All  [*551]  of the above is consistent with the suggestion that the Fed has a high degree of resistance to inappropriate political influence, even if it is not absolutely immune from such influence.  n287

There can be little dispute that the Fed has demonstrated well a key advantage of agency delegation: the rapidity of its policy changes in response to fluctuating economic conditions. In one recent period of just over a year, the Fed changed key interest rates seven times.  n288 Congress could never hope to be so nimble. Effective monetary regulation does not permit subjugation to the regular legislative process,  n289 because monetary policy is so important to so many groups that it is very likely that Congress would become a battlefield of competing interests. In other areas, Congress has been persistently deadlocked and important reforms have been delayed. There is every reason to believe that banks, thrifts, the real estate and construction industry, the retail industry, the auto industry, and even the government itself, which all have stakes in containing inflation or interest rates, would lobby Congress and frequently freeze it from acting at all. Instead, the Fed has proven that it is capable of moving quickly and decisively. Similarly, the Fed has also been able to move very quickly to stem potential financial melt-downs -- most famously in October, 1987, when the Fed flooded the markets with liquidity immediately after the 1987 crash.  n290 Virtually all commentators acknowledge the Fed's success in this area.  n291

 [*552]  Another benefit to expect from diminished political influence over regulation is the improved expertise in regulation. In a detailed study of the Fed's hiring practices with respect to top positions, Professor Woolley demonstrated that: (1) Fed officials are drawn from responsible financial positions in the private sector or academia; (2) the Fed hires personnel from elite backgrounds, such as prestigious educational institutions, more frequently than other government agencies, and at rates comparable to the private sector; and (3) Fed officials appear to vote independently of the positions previously held.  n292 All of this demonstrates that the Fed has assembled a staff of professionals who vote independently of parochial interests. This is consistent with the observations of others who have studied the Fed, for example, that the Fed is operated by officials "drawn from the broad American middle class" and are "splendid proof of an American meritocracy."  n293 According to regulatory theorists analyzing the causes of agency capture, one of the sources of capture is the temptation of agency staffers to allow the prospect of lucrative private employment to influence agency decisions.  n294 Professor Woolley determined that former Fed officials, however, do not achieve high posts in private finance, but instead migrate to nonfinancial positions.  n295 Finally, although Professor Woolley concluded that the banking industry naturally had some control over key personnel decisions, he also found that "it is very doubtful that the influence of the bankers through the recruitment process is sufficient to guarantee them detailed control of policy."  n296

 [*553]  So what does all of this mean? First, one must observe that there is no credible empirical, anecdotal, or logical basis for concluding that monetary policy, at least in modern times, has ever been hijacked by special interests regarding a major monetary policy decision.  n297 Second, although the Fed is not free of political influence transmitted through the executive or legislative branches, it is sufficiently independent that the political branches are quite challenged in influencing monetary policy and seem to have no ability to influence it on behalf of any one special interest. Instead, politicians have a difficult enough time attempting to influence monetary policy in order to enhance their electoral chances. The historical and empirical record suggests that the Fed has not exercised its power over monetary policy for the benefit of special interests.  n298

The Fed thus demonstrates the central points of this discussion: important economic regulation can be secured against the pernicious influences of special interests. Benefits of expertise, regulatory flexibility, and stability of policy can be secured, while special interest influence can be quelled. Monetary policy should not be subject to electoral politics because voters cannot be expected to master its intricacies. Though this recognition makes administrative regulation more appropriate, the economic stakes are so enormous that special interests cannot be permitted to influence such regulation. Consequently, Congress has endowed the Fed with the power to move quickly and expertly in administering monetary policy -- essentially free from the influence  [*554]  of special interests. This, in turn, informs the question of when depoliticized regulation is appropriate. This Article argues that depoliticization is an appropriate means of improving regulation, and not an attack on our republican tradition, when: (1) the voting public has insufficient time, interest and resources to make informed electoral decisions; (2) powerful interests exist that may benefit disproportionally from regulatory policy; (3) the costs of misregulation are diffused and deferred; (4) the regulatory environment evolves quicker than Congress can legislate; (5) competing power blocks may persistently "freeze" Congress; and (6) the regulated area is so complex that a high degree of expertise is necessary for effective regulation.  n299

The Fed is faced with a regulatory environment that fits these conditions like a glove. Monetary policy is an ideal area for depoliticization.  n300 The remainder of this Article evaluates and applies this model of depoliticized regulation to other areas of financial market regulation. A necessary predicate to this exercise is a clear understanding of the shortcomings of the current regulatory framework. Thus, Part III focuses on the problems inherent to the present regulatory approach, in order to determine if it too presents a set of circumstances appropriate for depoliticized regulation.

 [*555]  III. AN ASSESSMENT OF POLITICAL REGULATION OF FINANCIAL REGULATION

Political scientists long have recognized that administrative agencies, congressional oversight committees, and the business interests of the regulated may form an "iron triangle": a political subsystem that can subvert public policy in favor of policy choices dictated by select interest groups.  n301 The regulation of banks, other financial institutions, and financial markets generally, naturally is more inclined to succumb to these influences because these are "money" industries.  n302 Regulation is complicated further due to the presence of deposit insurance, which creates a unique moral hazard because poor banking may lead to costs that the government absorbs instead of making reckless decisions.  n303 Federally guaranteed deposit insurance can be a particularly attractive subsidy from a particular lawmaker's point of view; in the vast majority of circumstances the subsidy will never impose any cost upon the government during the lawmaker's life. Typically, deposit insurance is a deferred cost to the government that is imposed only about once a generation.  n304 Deposit insurance is illustrative of another dynamic of financial market regulation: the economic stakes can be huge.  n305 As is certainly the case in other areas of regulation, this enormous economic power, and the size of the economic stakes, expose a major flaw in our two-party system: a major check in our political  [*556]  system can be eliminated if both parties can be co-opted.  n306 When combined with low issue saliency, this environment is ripe for special interest abuses. Simply stated: "When it comes to financial regulation, the norm is for business to be conducted by those intimately connected to the enterprise with as little outside involvement as possible."  n307

Professor Jeffrey Worsham has undertaken a detailed study of agency regulation in the context of the banking industry.  n308 His conclusions provide a detailed explanation of the dynamics of banking regulation. Though Professor Worsham's study is limited to the banking industry, his findings provide a strong basis for generally explaining the dynamics of financial market regulation. Indeed, history demonstrates that the regulatory maladies he identifies permeate financial market regulation.  n309

Worsham's study offers a number of conclusions that support the thesis of this Article. First, ordinarily the banking industry dominates banking regulation.  n310 In a detailed study of the mechanics and output of the legislative process, Professor Worsham concluded that organized interests generally "reign supreme;"  n311 that is, the banking industry is at the head of a bank-dominant  [*557]  coalition that includes the banking industry itself, the federal banking regulators, and congressional committees.  n312 This political subsystem produces legislation that benefits banks disproportionately.  n313 This is particularly so when legislation can deliver concentrated benefits in exchange for diffuse or deferred costs.  n314 For example, the costs of relaxing regulation targeted at the safety and soundness of bank activities are deferred and diffused, while the benefits of relaxation accrue in the form of increased profits to the banking industry.  n315 These iron triangle tendencies are inconsistent with sound regulation.  n316

Second, though the bank-dominant coalition is the norm, transitory factors often subvert this coalition's power.  n317 Issue salience is the bane of special interests.  n318 When issues attract little public attention, special interests can impose their will with relative ease.  n319 Conversely, when issues attract a high degree of public interest, special interests can be defeated.  n320 Ordinarily, issues relating to financial market regulation do not attract the attention of the public. Thus, the bank-dominant coalition can work its will because of the public's general disinterest in financial market regulation, except in times of financial crises.  n321

Worsham applies his theory, convincingly, to the passage of the Bank Holding Company Act of 1956,  n322 by demonstrating  [*558]  that it initially had its genesis in the New Deal initiatives of the 1930s.  n323 Because such legislation was introduced in the late 1930s instead of the early 1930s, Worsham concludes that the "subsystem players" -- the "regulators and regulated" -- were able to prevent any restrictive legislation.  n324 By 1938, issue saliency for such reform was simply too low to thwart the special interest subsystem players.  n325 By 1956 they were able to modify the New Deal initiative enough to divert the regulatory energy to a fundamentally favorable outcome.  n326 In its final form, the Bank Holding Company Act insulated the banking industry from competition against insurance companies, like Transamerica, and generally expanded the powers of banks.  n327 Subsystem players -- specifically the banking industry and its regulators -- were able to achieve a result that protected the competitive turf of the banking industry and expanded investment opportunities.  n328 To secure the Act's passing, the Fed acceded to the American Bankers Association's insistence that the Act include a loophole for bank holding companies owning a single bank.  n329 This was key because it resulted in expanded bank activities;  n330 hence, the original New Deal initiative of curtailing bank holding companies to achieve a safer and sounder banking system was subverted completely.  n331

Economic dislocation can create political pressure for reform and lead other political actors, like the President, to wrest power from the bank-dominant coalition.  n332 The Great Depression led to the New Deal, which emphasized safety and soundness in  [*559]  regulation.  n333 The banking industry's ability to influence regulation receded and a variety of significant reforms, including the abolition of the state and federal dual regulatory regime, made it onto the congressional agenda.  n334 Transitory factors other than economic dislocation may increase the salience of a particular issue of bank regulation.  n335 For example, the bank bailout crisis of the 1980s produced major legislation that dramatically restructured the regulatory environment, and even abolished key parts of the iron triangle.  n336 Although these transitory factors occasionally serve to reduce industry domination, they do not assure that regulation is sound fundamentally or that our system of financial regulation is the best economically.  n337 For example, although political concerns awakened Congress to the savings and loan industry pillaging the Treasury, there was no real systematic review of deposit insurance and government guarantees in order to assure that this form of subsidy was well-controlled and dispensed only in appropriate circumstances.  n338

Professor Worsham's findings can be extended from banking regulation to financial market regulation generally. Specific examples of subsystem and iron triangle regulation can be drawn from the corporate governance area, the securities regulation area, and more recent forays of Congress into the financial institution reform area. All of these examples demonstrate that in a political environment financial market regulation is subject to "capture" by the very interests that are supposed to be regulated. Concentrated benefits are extended to these interests in exchange for deferred and diffused costs. Economic dislocation or issue salience may counteract these tendencies, but -- given the  [*560]  complexity of the subject matter and the rapid evolution of the regulatory environment -- increased public awareness does not necessarily restore sound regulation.

Transitory factors are also important in attracting the attention of the President.  n339 President Roosevelt was the agenda setter and ultimate source of political muscle that reformed the nation's financial structure in the wake of the Great Depression.  n340 In terms of the structure of our financial regulation regime, presidential leadership has been essential historically. For example, President Wilson was a primary supporter of the Federal Reserve Act and President Roosevelt was the primary mover behind the New Deal Bank regulatory initiatives as well as the federal initiative to regulate the securities markets.  n341 Presidents, though, are busy and easily distracted by foreign affairs or other matters.  n342 The natural consequence is that in the absence of transitory presidential interest, policy is subject to domination by special interests.

The enactment of the Private Securities Litigation Reform Act of 1995 (PLSRA)  n343 demonstrates these points. This Act quite simply stacked the deck against private securities plaintiffs in order to protect powerful business interests from the costs of litigation.  n344 Congress passed this Act even though there was no convincing empirical support of any need for such regulation  n345 and even though there was no evidence that the business interests pushing for the "Reform Act" were suffering unjustifiably.  n346 Commentators had argued that the private securities litigation system suffered from problems of extortionate settlements,  [*561]  which in turn caused economic damage.  n347 Nevertheless, the remedies for such problems far exceeded these justifications.  n348 Indeed, Congress could have remedied these problems with far more narrow solutions -- such as imposing a mandatory arbitration regime -- but chose instead simply to rig such litigation in favor of defendants.  n349 These putative defendants essentially captured Congress through a concerted, well-funded lobbying effort.  n350 They received rather concentrated benefits in the form of relief from litigation costs. The cost of these benefits were deferred by a slow erosion of investor confidence and diffused throughout the investing public.  n351 Although such costs may come due only once a century, when they are paid, the viability of capitalism itself can be called into question.  n352 Although the issue reached some level of saliency, public resistance was muted by portraying the Act as aimed at "entrepreneurial lawyers."  n353 Consequently, the PSLRA is an exemplary case of congressional capture.  n354 In the final analysis the public could not comprehend the complexity of the issue and had little incentive to resist the vested business interests.  n355 The SEC, the primary securities  [*562]  regulator, did not retain sufficient agency power to define investor remedies.  n356 Consequently, the special interests prevailed.

Another problem area for the SEC has been staffing. In the early 1980s, when deregulation was in vogue, SEC staffing suffered. Unfortunately, the securities markets were just beginning an era of expansive growth.  n357 The SEC found itself seriously underfunded.  n358 The Reagan Administration's emphasis on deregulation, backed by incomplete scholarly exposes on the problems plaguing regulatory agencies, thus left financial markets woefully underpoliced at a critical time.  n359 Frauds of unprecedented magnitude resulted.  n360 Michael Millken devised a new type of securities market, for junk bonds, built upon a "foundation of fraud and manipulation."  n361 The SEC eventually uncovered a multibillion dollar investment scheme that Prudential-Bache  [*563]  Securities fraudulently sold to thousands of retirees and other conservative investors, involving a web of scandal-ridden limited partnerships.  n362 Vast networks of nefarious insider trading festered in the darkness of deregulation.  n363 Though the costs of this debacle are difficult to calculate, the carnage in terms of real lives ruined is astounding.  n364

Another area that demonstrates the distorting effects of politics upon financial regulation is our nation's fragmented financial regulatory structure. Professor Roe, for example, has demonstrated persuasively that corporate finance has been influenced by political factors that have prevented corporate finance from evolving in accordance with economic pressures.  n365 Professor Roe focused on populist and progressive distortions of financial market structure, convincingly demonstrating that these elements, suspicious of concentrated financial domination by "Wall Street," influenced the structure of corporate finance.  n366 Other important elements have similarly distorted financial regulation. For example, financial institutions themselves work to decentralize regulatory power and protect their turf from other potential competitors.  n367 It is an open secret that the insurance industry would rather be regulated by "50 monkeys than one big gorilla."  n368 Thus, industry too seeks to fragment regulatory power, even if indirectly so, and to take advantage of the regulatory permissiveness that results. Industry also seeks fragmentation because of the ease of wielding political influence at the state  [*564]  level. As previously discussed, the Bank Holding Company Act is a piece of this same dynamic.  n369

For example, the United States traditionally has had a dual federal-state system of bank regulation.  n370 This system has spawned regulatory permissiveness and competition that has imposed real costs upon the United States taxpayer.  n371 During the 1980s, when the savings and loan crisis was brewing, a number of states began to deregulate their savings and loans.  n372 California, home of the infamous Lincoln Savings, and Texas were in the vanguard of this movement.  n373 California allowed thrifts chartered in that state to operate "virtually free of any constraints."  n374 Of course, in light of federal deposit insurance, there were few incentives for states to be concerned about prudential regulation of state-chartered thrifts. As long as the federally backed deposit insurance fund bore responsibility for making good the losses of a failed state-chartered thrift, "there was no great incentive for many state legislators to deny the sweeping demands for additional investment powers made by the thrift industry."  n375 California also slashed its regulatory personnel and granted their state-chartered thrifts expansive investment  [*565]  powers.  n376 California allowed its thrifts to operate everything from windmill farms to horse-breeding operations.  n377 According to Edwin Gray, Chairman of the Federal Home Loan Bank Board (FHLBB), during the early 1980s, such promiscuous lawmaking was the natural cause of the dual-chartering system: "the only motivation for [dual-chartering] seems to have been to provide . . . political contributions from those who are regulated for persons who make and administer state thrift laws."  n378 Ultimately, taxpayers from coast to coast paid for this folly. In 1988 alone, state-chartered thrifts in Texas and California accounted for seventy percent of the Federal Savings & Loan Insurance Corporation's expenditures.  n379 This sordid episode of regulatory competition occurred even though scholars had long catalogued, and warned of, the problems arising from such competition.  n380

Even beyond regulatory competition, politics was the driving force in the spectacular regulatory failure leading to the savings and loan crisis of the 1980s.  n381 Indeed, there is now a growing consensus that that much of the $ 1 trillion in costs arising from this debacle is attributable to political distortions of regulatory policy.  n382 These political distortions have their origins in severe  [*566]  failures by Congress as well as the primary thrift regulator, the FHLBB, to resist the political influence of the savings and loan industry.  n383 One of the fundamental reasons why the savings and loan crisis grew into such a large problem was because of political decisions made to deprive regulators of the funding necessary to resolve the crisis, and deregulation initiatives that supposedly would open more opportunities to thrifts but really just exposed them to greater risks.  n384 Insolvent depository institutions cannot be closed without adequate funds because depositors must be given the benefit of deposit insurance payments to the extent deposit liabilities exceed assets.

Depriving regulators of the funds needed for the shutdown of insolvent thrifts allows only losses to mount because it is exceedingly difficult for a depository institution to make money when it has more liabilities than assets. Banks survive on the margin by which income on assets exceeds the cost of liabilities,  n385 so it helps to have more assets than liabilities. Similarly, allowing an industry that traditionally had made mortgage loans upon the collateral of single-family residential homes to suddenly assume riskier lending that the industry is ill-prepared to underwrite and manage is a certain way to increase losses. Together, deferring the shutdown of ailing thrifts and at the same time expanding the risks they could undertake proved a volatile mix.

The thrift crisis had its genesis in the high interest rates of the late 1970s.  n386 Most thrift assets were long-term, low-interest  [*567]  rate home mortgages.  n387 Most thrift liabilities were short-term deposits.  n388 When short-term interest rates soared, thrifts hemorrhaged money; most of their assets were locked in at low rates while the cost of their liabilities soared.  n389 By 1981, the industry's net worth had evaporated.  n390 In accordance with then prevailing political winds, the initial response to this problem was to deregulate the industry.  n391 In 1982 the Garn-St. Germain Depository Institutions Act became law and the scope of thrift activities expanded.  n392 This initially caused a huge growth in industry assets. Indeed, while industry assets grew by fifty percent between 1982 and 1984, the staffing of thrift regulatory agencies stagnated in accordance with deregulation vogue.  n393 The FHLBB, the primary industry regulator, requested a significantly increased budget for 1985, which the Reagan Administration rejected.  n394 Indeed, according to Edwin Gray, he "begged" annually for more supervisory personnel to regulate the burgeoning thrift industry, but the Reagan Administration responded by questioning his loyalty to its deregulation agenda.  n395

The FHLBB certainly did not have clean hands in this fiasco. Instead, the FHLBB was a willing participant in a convoluted scheme to sweep the thrift crisis under the carpet.  n396 In the early  [*568]  1980s it was clear that the savings and loan industry was in the midst of a deepening crisis.  n397 Still, if the most insolvent thrifts had been closed at this point, tens of billions of dollars could have been saved. Industry lobbying groups persuaded the FHLBB to adopt new accounting standards called "Regulatory Accounting Principles."  n398 This accounting approach allowed losses to be transformed into assets by allowing thrifts to spread certain losses over a period of up to forty years.  n399 This masked the worsening financial condition of the industry and allowed institutions that should have been shut down to remain in business.  n400

Predictably, this