The Financial World Enters the Era of Re-Regulation

Michael Butler is chairman and CEO of investment bank Cascadia Capital. He is writing a book titled Financing the Future and the Next Wave of 21st Century Innovation, and is serializing it here at peHUB. What follows is an excerpt from the eighth chapter.

It’s been nearly 30 years since Ronald Reagan tore down the walls of regulation and ushered in a new era of smaller and less involved government.

But 30 years is a long time – a full generation, in fact – and the pendulum appears to be swinging back toward greater government regulation of business.

Actually, the pendulum has already swung back – and in a major way. Ever since the rescue and fire sale of Bear Stearns, The Federal Reserve has been steadily but surely asserting itself by inserting itself in Wall Street’s affairs.

This involvement shows no sign of abating, and I believe it will lead to a new and significant regulatory infrastructure. We can already see the emerging outlines of a possible nationalization of Fannie Mae and Freddie Mac; investment banks will experience more oversight from Washington; short sellers will be scrutinized; excessive leverage is being examined by legislators; the oil futures market is under investigation; utilities will be monitored more closely; and the government has shown us that it will do whatever it takes to prop up and support the housing markets.

So far, most of the regulatory inroads have been in the financial, energy and housing sectors of the economy. But it’s very logical to assume that government intervention will spread to other industries in due course.

Like it or not, the bottom line is that there will be more Federal regulation of business over the next four years than at any time since the late 1970’s. And if Barack Obama is elected President, the move toward nationalization and re-regulation will be even more pronounced.

I’m an unabashed capitalist – and I’ve been an investment banker for more than 20 years – so I understand that the knee-jerk reaction to all this is apprehension and maybe antipathy. That’s the normal response from the private sector. People building enterprises don’t like to be messed or meddled with. And to the extent that regulation becomes an impediment and industries are nationalized, they are right – and I’m with them.

This may be heresy from a guy who has been doing deals for several decades, but I believe there are a number of legitimate opportunities for public-private sector collaboration. And these opportunities can be very beneficial for a wide range of constituencies within our country.

The key premise for a successful public-private joint venture – at least in my view – is that an investment initiative is solidly in the public interest. It must also require more capital, and have a higher risk profile and longer time frame than most private entities can handle on their own.

I’m not in any way, form or fashion proposing another New Deal or Great Society; nor am I going to claim that a Reagan-like laissez-faire approach can help us solve the huge global problems that gnaw at the fiber and fabric of our society today. What I’m saying, though, is that a pragmatic blend is the way to go, a mixture of public-sector muscle, scale and scope and private-sector agility, innovation and drive. Issues like global warming are unprecedented and require the best and brightest to coalesce and come together – whether they’re legislators, community leaders or CEOs.

Right now, I see four major opportunities for public-private collaboration:

Infrastructure Projects
The Industrial Revolution could not have taken place in the late 18th and early 19th centuries without better infrastructure. The same is true today. We cannot build out the New Energy Economy of the 21st century without sustainable infrastructure that accommodates and acknowledges the beginning of the post-petroleum era. We must upgrade and modernize the highway systems, railroad tracks and shipping processes that were constructed in the 1950s under President Eisenhower. And government and the private sector must put their heads and wallets together on this.

Research & Development

Basic research, which costs in the neighborhood of tens and tens of billions of dollars a year, is an area where the private sector has trouble going because of the uncertainty and length of time it takes to generate economic returns. This is innovation with a long-term horizon. So government can be helpful and a good partner here by taking on funding through its labs as well as universities, which can achieve breakthroughs in disciplines like health care. And Washington, in particular, can help fund national initiatives in alternative energy that have significant capital requirements and long-haul paybacks.

Appropriately Pricing Existing Solutions
Government regulation can help spur innovation and level the playing field so new and better products and services can compete in the marketplace. A carbon tax or tariff on oil and other polluting energy sources and processes, for example, would appropriately and accurately price these existing solutions. As a result, consumers and customers would be able to put economics aside and make choices based on personal preference and environmental merits not dollar outlays.

Incentives to Jump Start Strategically Important Initiatives
A good example here might be tax benefits in the form of investment tax credits (ITC) for the fledgling solar power industry. The government has determined that the development of renewable energy is a strategic priority and the private sector has invested in solar. But solar isn’t cost competitive right now – and won’t be until the technology is more fully developed and economies of scale are developed. So, we are faced with a chicken-and-egg situation: how does the solar industry get economies of scale if it’s not cost competitive today? The sheer amount of capital required for subsidizing carrying costs to get to scale and cost competitiveness is way too much for the private sector to handle on its own. That’s why the government – at both the state and federal levels – has stepped in with tax credits to fill the financing void and enable solar to achieve cost parity. This is an interesting model to watch – and perhaps follow.

Some of the best examples of public-private partnerships are currently taking place at the state levels. Oregon’s progressive tax code, for instance, has encouraged the growth of sustainable industries in a number of solid – but creative – ways. New Jersey has an extremely popular incentive program that has boosted solar power’s fortunes and prospects. And California, which produces roughly 6.2 percent of total U.S. greenhouse gases (GHG), passed landmark legislation in 2006 that established a first-in-the-world program of regulatory and market mechanisms to achieve real, quantifiable, cost-effective reductions of GHG.

A lot of people think that the next president should pledge support for a huge and sweeping green governmental initiative. Baby Boomers, especially, yearn for another John F. Kennedy – who promised to put a man on the moon within a decade.

But I don’t think this is the way to go this time. Instead, we need to be strategic rather than grandiose. What do we need to unleash private enterprise in this country so capital can be put to work in an efficient and effective way on behalf of 300 million people? That’s the question we have to ask ourselves. We can’t worry about making splashy headlines. We have to focus on staying competitive in a brutal global marketplace. And we have to try to find middle-ground ways of bringing public policy makers and private sector executives and entrepreneurs into the same deals.

That’s why it wouldn’t be such a bad idea for the next president to create a Cabinet-level position for coordinating public-private initiatives across the board.

We can do it. And to be perfectly honest – we have to do it. Ideology and labels must go away or our big and seemingly intractable problems will be here to stay.