The Effects of Deregulation
Deregulation, both of airlines and of other industries, has its negatives. The greater pressure of competition led to entry and exit. When firms went bankrupt or contracted substantially in size, they laid off workers who had to find other jobs. In the airline industry, several major airlines, including Eastern, Pan Am, and Continental, all went bankrupt after deregulation. Market competition is, after all, a full-contact sport.
As a result, a number of major accounting scandals involving prominent corporations such as Enron, Tyco International, and WorldCom led to the Sarbanes-Oxley Act in 2002. Sarbanes-Oxley was designed to increase confidence in financial information provided by public corporations to protect investors from accounting fraud.
Similar to the effects of deregulation, a lack of regulation can also have negative impacts on the market. For example, investors need reliable information when deciding whether or not to purchase stock in a corporation. They need to know how risky that decision is. Financial markets work best when investors have good information about risk and return. Historically, some of this information is provided when a corporation is audited by an outside accounting firm. However, prior to 2002, those same accounting firms were also paid large fees for consulting work. Therefore, there was the potential for conflict of interest. In order to maintain their lucrative consulting work, the accounting firms may have had an incentive to downplay, or not report, any risk associated with the firms they were auditing. Thus, investors did not receive the information needed to make the correct investment decision.
The Great Recession began in late 2007 and was caused, at least in part, by a global financial crisis, that began in the United States. A significant factor that contributed to the financial crisis was various financial innovations created for the mortgage industry. Information technology facilitated the introduction of several types of new and unregulated financial assets that seemed safe at the time of their implementation. These nascent assets included collateralized mortgage obligations (CMOs, a type of mortgage-backed security), and credit default swaps (CDSs, insurance contracts on assets like CMOs that provided a payoff even if the holder of the CDS did not own the CMO). Many of these assets were rated very safe by private credit rating agencies, such as Standard & Poors, Moody’s, and Fitch.
The collapse of the markets for these assets precipitated the financial crisis and led to the failure of Lehman Brothers, a major investment bank, numerous large commercial banks, such as Wachovia, and even the Federal National Mortgage Corporation (Fannie Mae), which had to be nationalized—that is, taken over by the federal government.
One response to the aftermath of the precipitous decline in the housing and financial markets was the passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act, known as the Dodd-Frank Act. In order to avoid another financial crisis, the bill took several steps. It examined and increased the regulation of companies offering mortgages and it gave the FDIC the power to intervene in troubled commercial banks. The Dodd-Frank Act also created an oversight council that would attempt to identify market bubbles as they were taking place.
While some argue that the Dodd-Frank Act will protect the US economy from experiencing another financial crisis like in 2007-2009, others contend that it is responsible for the slow economic growth that followed the recession. These critics argue that the bill contained too much regulation and hampered financial markets. We will explore the financial crisis and subsequent Great Recession in more detail in the macroeconomic chapters of this book.
All market-based economies operate against a background of laws and regulations, including laws about enforcing contracts, collecting taxes, and protecting health and the environment. The government policies discussed in this chapter—like blocking certain anticompetitive mergers, ending restrictive practices, imposing price cap regulation on natural monopolies, and deregulation—demonstrate the role of government to strengthen the incentives that come with a greater degree of competition.
Bring It Home
More than Cooking, Heating, and Cooling
What did the Federal Trade Commission (FTC) decide on the Kinder Morgan / El Paso Corporation merger? After careful examination, federal officials decided there was only one area of significant overlap that might provide the merged firm with strong market power. The FTC approved the merger, provided Kinder Morgan divest itself of the overlap area. Tallgrass purchased Kinder Morgan Interstate Gas Transmission, Trailblazer Pipeline Co. LLC, two processing facilities in Wyoming, and Kinder Morgan’s 50 percent interest in the Rockies Express Pipeline to meet the FTC requirements. The FTC was attempting to strike a balance between potential cost reductions resulting from economies of scale and concentration of market power.
Did the price of natural gas decrease? Yes, rather significantly. In 2010, the wellhead price of natural gas was $4.48 per thousand cubic foot; in 2012 the price had fallen to just $2.66. Was the merger responsible for the large drop in price? The answer is uncertain. The larger contributor to the sharp drop in price was the overall increase in the supply of natural gas. More and more natural gas was able to be recovered by fracturing shale deposits, a process called fracking. Fracking, which is controversial for environmental reasons, enabled the recovery of known reserves of natural gas that previously were not economically feasible to tap. Kinder Morgan’s control of 80,000-plus miles of pipeline likely made moving the gas from wellheads to end users smoother and allowed for an even greater benefit from the increased supply.