Oren Cass’s Unquenchable Appetite for Regulation

In Metamorphosis, Ovid tells the story of the Thessalian noble Erysichthon, who offended Ceres by chopping down a favorite oak in her sacred grove. Ceres cursed Erysichthon with a paradox: the more he ate, the hungrier he got.

The more he puts away inside, the greater his desire. As the ocean receives the rivers of all the earth, and unfilled by the waters, swallows every wandering stream: as the devouring flames never refuse more fuel, burn endless timber, and look for more, the greater the piles they are given, more voracious themselves by being fed: so Erysichthon’s profane lips accept and demand all foods, in the same breath. All nourishment in him is a reason for nourishment, and always by eating he creates an empty void.

In legend, Erysichthon ate so much that he became so hungry that he eventually consumed his own body.

That story is not entirely a myth. It is an apt metaphor for the expanding imperial predation of the regulatory state. Many regulations and state interventions create distortions that “create an empty void,” requiring even more regulation to compensate. But since the void was created by regulation in the first place, it can never be enough. Eventually, the regulators consume themselves, and the industry they oversaw.

History is full of examples. Adam Smith rightly derided mercantilist trade restrictions and guild restrictions that hobbled progress and growth, while enriching a few privileged groups. The Interstate Commerce Commission propped up prices in ground transport; the Federal Aviation Administration did likewise for airlines.

The finance industry in the United States was largely unregulated and subject to frequent disruptions and convulsions. After the Securities Exchange Act of 1934, though…. well, it has still been subject to disruptions and convulsions. Unsurprisingly, progressive politicians and policy analysts have a fever; the only prescription is more regulation, the nerd equivalent of more cowbell.

When one looks back at the major regulatory changes, the effect is clearly a ratchet. The two most significant regulatory regime changes, Sarbanes-Oxley and Dodd-Frank, dramatically expanded the scope and complexity of regulatory requirements. George Stigler, George Benston, and Jonathan Macey present a variety of theoretical and empirical claims that the effect of financial regulation has been to increase reporting costs, reduce transparency, and raise entry barriers to new, nimble small firms. Dodd-Frank, in particular, has been a catastrophe, doing little to curb the “too big to fail” impulse but creating insurmountable fixed-cost entry barriers for new firms.

Into this mess steps Oren Cass with his recent New York Times opinion piece. I have heard Cass dismissed as the “pet conservative” of Progressives, because he nimbly parrots their regulatory objectives. But his argument is sincere, and his views represent those of many young conservatives, and so should be addressed seriously.

A concession at the outset: Mr. Cass is right about the shape of the problem, even if (in my view) he draws the wrong causal arrow and therefore reaches the wrong policy prescription. He begins on solid ground: Mary Poppins, Mr. Dawes, and the old story of intermediation. Real, honest-to-goodness banking is a brokering function, collecting savings from many, aggregating those funds, and investing in productive projects and ideas.

And he’s on target also when he points out that most Wall Street activity is now detached from that purpose. Less than 10 percent of Goldman’s revenue (2024) came from helping businesses raise capital; loans to operating businesses were a tiny fraction of assets; and the “new capital” raised often funds refinancing, stock buyouts, and acquisitions rather than building new things.

But he is naïve in failing to ask why those things are true. If the spectacular compensation in finance is not payment for socially productive intermediation, then Wall Street must have become a gaudy carnival of rent-seeking. The obligations imposed by regulators have (to use Adam Smith’s word, in just this context) “deranged” the market, distorting incentives and perverting institutions away from their proper ends.

What leaves me incredulous is Cass’s economically tone-deaf “solution”: more regulation, lots of it. What’s needed to escape the excessive and deranging regulation is a fresh round of ambitious federal rule-making—transaction taxes, changes to bankruptcy priority rules, ceilings on executive compensation, and a ban on buybacks.

Even ignoring the fact that the derangement was caused by regulation in the first place, such an approach assumes a regulator standing outside the industry, neutrally constraining it. But the post-2008 experience points uncomfortably in the opposite direction: Congress and the agencies were thickly lobbied throughout the Dodd-Frank legislative and rulemaking process, with predictable advantages for incumbent firms that can afford influence and compliance at scale. Consider:

·       A careful Baker Institute analysis finds that Dodd-Frank “roughly doubled the number of regulations applied to U.S. banks,” increasing compliance costs by more than $50 billion per year, with disproportionately large and statistically significant cost increases for small banks (legal fees, auditing, consulting, data processing, and other non-salary expenses).

·       The GAO likewise reports that while many Dodd-Frank reforms were aimed at large institutions, regulators and industry groups identified provisions expected to impose additional requirements and costs on community banks that could affect them “disproportionately relative to larger banks.” This is the basic “army of nonproductive report-filers” problem: once compliance becomes a high fixed cost, scale becomes a moat. Moats protect incumbents; Cass wants to make the moat deeper and smellier.

·       New bank entry collapsed in the very period we expanded the regulatory superstructure.
A Federal Reserve staff paper documents a dramatic drop in new bank charters: over 2,000 new banks formed from 1990 to 2008 (more than 100/year), but only 7 formed from 2009 to 2013. The authors note that many observers attribute the decline to increased regulatory burden, including Dodd-Frank (while also evaluating macroeconomic explanations).

·       Just two weeks ago, Reuters reported that industry lawyers describe today’s authorization process as a “nearly impenetrable barrier to entry,” pointing out that approvals averaged only about five per year (2010 to 2023) versus 144 per year (2000 to 2007).

·       Dodd-Frank contains explicit entry suppression in at least one important channel. Congress’s own CRS review notes that Section 603 of Dodd-Frank imposed a moratorium on granting deposit insurance to new industrial loan companies (ILCs). After the moratorium ended, CRS reports that the FDIC approved no new ILC applications for more than six years (until March 2020). Whatever one thinks of ILC policy, this is a straightforward example of the post-crisis regulatory state foreclosing a route by which new competitors — including technology-enabled entrants — might have challenged incumbent banking models.

What we have learned is that complex rules, combined with intensive lobbying, produce a system that is easiest for big incumbents to navigate—and to bend. More regulation would mean more, not less, insulation for executives of the existing firms. Modern finance does look like a grift, Cass has that right. But the grift depends on protective regulation to insulate the fat cats from the scolding winds of competition. Members of Congress have been quite happy to build a regulatory architecture that socializes downside risk through explicit and implicit safety nets and crisis interventions, and privatizes upside rents behind entry barriers.

Which brings me to the macro point. If the solution is not more regulation, what explains the size of the huge flows of capital that are filling Wall Street coffers to overflowing?  It’s a fair question; I happen to know the answer. Over the last two decades — accelerating after 2008 and again after 2020 — U.S. fiscal and monetary policy have been unprecedentedly expansionary. We saw expansions of the money supply and fiscal deficits orders of magnitude larger than anything the U.S. has ever done in peacetime. Meanwhile, broad money measures and the central bank's balance sheet expanded sharply during this same period, as the Fed purchased private assets and created new money to accommodate the deficit. 

Policy has been reorganized around an apparently permanent regime of cheap liquidity, backstops, and rescue expectations in case of “crisis.” This has been a category five fiscal and monetary hurricane, where no one knows what policy will look like. It is unsurprising, then, that the highest private returns show up in asset inflation trades, financial engineering, and regulatory arbitrage, rather than in the slow work of matching patient capital to productive enterprise.

Cass’s “more regulation” program is just an all-you-can-eat buffet for Wall Street and K Street. If we take his advice, we’ll see only another round of byzantine rules that these insatiable Erysichthons can afford, know they can influence, and will use to eat competitors.

Michael Munger is Professor of Political Science and Economics at Duke University. His research focuses on the relations between political and commercial institutions.