Can Deregulation Go Too Far? Lessons from U.S. History

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The role of government in the economy is one of the most enduring debates in American public life. At the heart of this debate is regulation – the rules the government imposes on businesses and individuals to achieve public goals like safety, fairness, and stability.

Deregulation, the process of reducing or removing these rules, is often presented as a way to unleash economic growth and innovation. Proponents argue that it cuts burdensome red tape, lowers prices for consumers, and allows American businesses to compete more effectively on the world stage.

However, critics warn that removing these guardrails can expose consumers, workers, and the environment to unacceptable risks, and can even trigger catastrophic economic crises.

What is Deregulation? A Balancing Act

Deregulation is the formal process of reducing or eliminating government rules and restrictions on a specific industry or the broader economy. This action isn’t arbitrary – it must be implemented through specific government channels, such as the passage of new legislation by Congress, the issuance of an executive order by the President, or a decision by a federal agency to stop enforcing an existing regulation.

It’s important to distinguish deregulation from privatization. While both involve shifting economic activity away from government control, deregulation alters the rules for private businesses, whereas privatization involves the transfer of state-owned enterprises into private hands.

The modern deregulation movement in the United States gained significant momentum in the 1970s and 1980s, attracting bipartisan support as a response to economic challenges and a growing belief that the heavy regulatory framework built after the New Deal had become inefficient and burdensome.

This shift in thinking proposed that market forces, rather than government mandates, were better suited to deliver efficiency and innovation.

The Proponents’ Case: Unleashing the Market

The central argument for deregulation is that it fosters a more dynamic and efficient economy by promoting free-market competition. The intended benefits cascade from this core principle.

Increased Competition and Lower Prices

Proponents argue that government regulations often act as barriers to entry, protecting established firms from new challengers. By removing these barriers, deregulation allows new businesses to enter a market, forcing all companies to compete more vigorously on price and quality.

This increased competition is expected to drive down prices for consumers, a key and often-cited benefit.

Spurring Innovation and Efficiency

In a competitive, deregulated marketplace, companies are incentivized to innovate and streamline their operations to gain an edge. This can lead to the development of new products, better services, and more efficient business practices as firms strive to outperform one another.

Reducing Costs and Fueling Reinvestment

Adhering to complex regulations imposes significant compliance costs on businesses, often referred to as “red tape.” Proponents of deregulation contend that these costs divert capital and resources that could be used more productively.

By freeing companies from these obligations, deregulation allows them to reinvest in core business activities like research and development, expansion, and hiring, thereby stimulating broader economic growth.

The Critics’ Case: The Risks of an Unguarded Market

Opponents of deregulation counter that government rules aren’t simply burdens – they’re essential safeguards. They warn that removing these protections can lead to severe negative consequences for society, arguing that a purely free market doesn’t adequately account for public welfare.

Market Concentration and Monopolies

Critics argue that in a deregulated environment, the “free market” isn’t always a fair fight. Larger, more established companies can leverage their market power, economies of scale, and capital reserves to undercut and drive smaller competitors out of business.

This can lead to industry consolidation and the formation of monopolies or oligopolies, which ultimately harms consumers by reducing choice and allowing dominant firms to dictate prices.

Harm to Consumers, Workers, and the Environment

Many regulations are explicitly designed to protect the public from harm. These include health and safety standards for food, medicine, and consumer products; rules ensuring safe working conditions and fair labor practices; and environmental laws aimed at preventing air and water pollution.

Critics warn that deregulation can weaken or eliminate these vital protections, prioritizing corporate profits over public health and environmental quality. A worst-case scenario without federal regulations could see a rise in hazardous products, unsafe workplaces, and the elimination of worker protections like overtime pay or weekends.

Financial Instability and Systemic Risk

The financial sector is a particular area of concern. Critics argue that without prudent oversight, financial institutions are incentivized to take on excessive risk in pursuit of high returns.

This can lead to asset bubbles, institutional failures, and, in the worst cases, catastrophic financial crises that threaten the stability of the entire economy – a phenomenon known as systemic risk.

The debate over deregulation, therefore, isn’t merely a technical economic discussion. It’s fundamentally an ideological one, reflecting a deep-seated disagreement about the proper role of government.

Is government primarily a source of “burdensome red tape” that stifles prosperity, or is it a necessary protector against the “market failures” and potential harms that can arise when private interests are left entirely unchecked?

This tension between the values of free enterprise and the need for public protection is a recurring theme throughout the history of American economic policy.

Five Case Studies from U.S. History

To understand the real-world consequences of deregulation, it’s essential to move beyond theory and examine its historical application. The following five case studies from different sectors of the U.S. economy illustrate the complex and often unintended outcomes that can result when government steps back.

The Skies Open Up: Airline Deregulation (1978)

The deregulation of the U.S. airline industry is often held up as a classic example of the policy’s intended benefits, but it also serves as a powerful illustration of its significant and unevenly distributed costs.

The Pre-Deregulation Era

Before 1978, the airline industry operated under the tight control of the Civil Aeronautics Board. This federal agency dictated which airlines could fly which routes, set all passenger fares, and effectively blocked new airlines from entering the market.

While this system ensured that even small communities received air service, it did so by keeping prices artificially high and stifling competition.

The 1978 Act and Its Goals

With growing bipartisan consensus that the CAB’s control was inefficient, Congress passed the Airline Deregulation Act of 1978. The law’s primary objective was to phase out the CAB and allow market forces – competition – to determine prices and service levels, with the ultimate goal of making air travel more affordable for the American public.

The Positive Outcomes

In many respects, the act delivered on its central promise.

Lower Fares (On Average): With airlines free to compete on price for the first time in decades, fares plummeted on many routes. A 2006 Government Accountability Office report found that the median airfare had declined by almost 40% in real, inflation-adjusted dollars since 1980. Other analyses estimated that passengers saved billions of dollars annually.

Increased Travel: The dramatic drop in prices made flying accessible to a much broader segment of the population. Air travel was no longer a luxury reserved for the wealthy, and the total number of passengers flying each year more than doubled in the decades following deregulation.

The Negative Consequences and Unintended Effects

The benefits of deregulation were not universal, and the new, fiercely competitive environment produced significant downsides.

Loss of Service to Smaller Communities: As critics of the act had predicted, airlines quickly abandoned their less profitable routes to focus on high-volume corridors. This led to the development of the “hub-and-spoke” system, where major airlines channeled flights through a few large airports.

While efficient for the airlines, this model often left smaller cities and rural towns with drastically reduced or eliminated service. Multiple GAO reports over the years documented this trend, finding that many small and medium-sized communities, particularly in the upper Midwest and the South, saw service decline even as the national average increased.

Communities like Dubuque, Iowa, and Toledo, Ohio, eventually lost all scheduled service.

Industry Consolidation: The intense “cutthroat competition” warned of by regulation proponents led to a wave of bankruptcies and mergers. Iconic carriers like Pan Am, TWA, and Eastern Airlines collapsed, and the industry, once populated by numerous players, consolidated into a handful of dominant mega-carriers.

This has raised concerns that on many routes today, a lack of meaningful competition allows the remaining airlines to keep fares artificially high.

The Air Ambulance “Surprise Bill” Crisis: A critical and devastating unintended consequence emerged from a legal loophole in the 1978 Act. The law preempts, or blocks, states from regulating the “rates, routes, or services” of any air carrier. Courts have interpreted this to include emergency air ambulance services.

As a result, air ambulance companies can operate as out-of-network providers and are free from state price controls. This has allowed them to charge patients in life-or-death situations exorbitant fees, often ranging from $36,400 to $40,600 for a single flight, leaving critically ill patients and their families with crippling surprise medical bills.

The experience of airline deregulation reveals a crucial lesson: the benefits and costs of deregulation are rarely distributed evenly. The policy was a clear victory for travelers on popular, competitive routes between major cities.

However, for Americans in smaller, less-trafficked markets, it often meant higher fares, fewer choices, and less convenient service. The rational, efficiency-seeking decisions of private airlines in a deregulated market didn’t align with the broader public policy goal of ensuring equitable access to the national transportation network, thereby creating a new form of regional inequality.

A House of Cards: The Savings & Loan Crisis (1980s)

The Savings & Loan crisis of the 1980s stands as a catastrophic failure of economic policy and a textbook example of how poorly designed deregulation, when combined with government guarantees, can create a perfect storm of perverse incentives, reckless behavior, and ultimately, a massive taxpayer bailout.

The S&L Business Model Under Strain

For decades, Savings & Loan institutions, also known as “thrifts,” operated under a simple, heavily regulated model: they accepted deposits from local customers and used that money to issue long-term, fixed-rate home mortgages.

This model was stable in a low-inflation environment. However, the stagflation of the late 1970s, with its soaring interest rates, shattered this stability.

S&Ls found themselves in a financial vise: federal regulations capped the interest rates they could pay on deposits, causing savers to pull their money out in favor of higher-yielding investments like money market funds. At the same time, the S&Ls were stuck holding portfolios of old, low-interest mortgages whose value had plummeted.

By the early 1980s, the entire industry was effectively insolvent, with a collective negative net worth of $100 billion when its assets were valued at market prices.

The Flawed Deregulatory “Fix”

Faced with a deepening crisis, Congress and regulators opted not for a direct, costly resolution but for a deregulatory gamble. Through two key pieces of legislation – the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Depository Institutions Act of 1982 – they radically altered the rules for S&Ls.

These acts allowed S&Ls to diversify away from safe home mortgages and invest in much riskier ventures, including commercial real estate, speculative land developments, and junk bonds. They also phased out the interest rate ceilings on deposits, allowing thrifts to attract funds by offering aggressively high rates.

The Critical Flaw: Moral Hazard on a Massive Scale

This deregulation was fatally flawed because it unleashed risk-taking on one side of the S&Ls’ balance sheets while leaving a critical government backstop on the other side not only intact, but strengthened.

Federal Deposit Insurance: Every dollar deposited in an S&L was insured up to $100,000 by the Federal Savings and Loan Insurance Corporation, a government agency. This created a severe “moral hazard”: depositors had no incentive to scrutinize the financial health of their S&L, as their money was guaranteed by the taxpayer regardless of how recklessly the institution behaved.

Troubled S&Ls could easily attract huge sums of money simply by offering the highest interest rates.

Insolvent “Zombie” Thrifts and Regulatory Forbearance: Compounding the problem, federal regulators engaged in “regulatory forbearance,” a policy of deliberately looking the other way. They allowed hundreds of technically bankrupt S&Ls – so-called “zombie thrifts” – to remain open, and even lowered the capital standards they were required to meet.

These zombies, with nothing left of their own to lose, had a powerful incentive to “gamble for resurrection.” They used the flood of federally insured deposits to make wildly speculative investments. If the bets paid off, the owners would get rich. If they failed, the FSLIC – and by extension, the American taxpayer – would be left with the bill.

The Collapse and Bailout

The result was a frenzy of fraud, abuse, and reckless lending, epitomized by figures like Charles Keating of Lincoln Savings, who looted his institution before its collapse.

When the speculative bubble in commercial real estate burst in the mid-1980s, the house of cards came down. More than 1,000 S&Ls failed, wiping out the FSLIC.

The federal government was forced to step in with the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, a massive rescue package that created the Resolution Trust Corporation to clean up the mess. The final cost to taxpayers was staggering, estimated at $124 billion.

The S&L crisis was not a simple failure of deregulation, but a failure of incoherent deregulation. By liberalizing the investment powers of S&Ls without reforming the flat-rate deposit insurance system that distorted risk, and by simultaneously weakening capital requirements and supervisory oversight, policymakers created a system that actively rewarded the most irresponsible behavior.

It was a toxic interaction between newfound market freedoms and old, unreformed government guarantees.

The Lights Go Out: The California Electricity Crisis (2000-2001)

The California electricity crisis of 2000-2001 serves as a stark warning about the dangers of poor market design in deregulation. It demonstrates how a partially deregulated system, crafted with conflicting goals, can create perverse incentives that lead to market manipulation, supply shortages, and economic chaos.

The Deregulation Plan (Assembly Bill 1890)

In 1996, with broad political support, California passed Assembly Bill 1890 to restructure its massive electricity market. The goal was to break up the traditional utility monopolies and introduce competition among power generators, which was expected to improve efficiency and lower prices for consumers.

Under the new system, the state’s three large investor-owned utilities – Pacific Gas & Electric, Southern California Edison, and San Diego Gas & Electric – were required to sell off most of their fossil-fuel power plants. They would then have to purchase the electricity needed to serve their customers on a newly created wholesale spot market, operated by the California Power Exchange.

The Design Flaw: A Price Vise

The architecture of this new market contained a fundamental and ultimately fatal flaw. It created a “price vise” that squeezed the utilities between two contradictory policies.

Volatile Wholesale Prices: On the wholesale market where utilities bought their power, prices were determined by real-time supply and demand and were allowed to fluctuate wildly. Furthermore, utilities were largely prohibited from signing long-term contracts for power, which would have allowed them to lock in stable prices and hedge against volatility. They were forced to rely almost entirely on the volatile daily spot market.

Frozen Retail Prices: On the retail side where utilities sold power to consumers, prices were frozen at pre-deregulation levels by the California Public Utilities Commission. This was a political decision designed to shield consumers from price spikes and deliver the promised benefits of deregulation immediately.

This design created a financially untenable situation: utilities could be forced to buy power on the wholesale market for an uncapped, high price while being legally obligated to sell it to their customers for a capped, low price, guaranteeing massive losses.

Market Manipulation and Supply Shocks

This structurally flawed market became a playground for sophisticated energy traders, most notoriously from the Houston-based company Enron. They devised a host of manipulative schemes with colorful names like “Death Star,” “Fat Boy,” and “Ricochet.”

These strategies involved creating artificial congestion on transmission lines, exporting power out of the state to create artificial shortages, and then selling it back at inflated prices. Tapes of Enron traders later revealed them bragging about gouging “Grandma Millie” in California.

This manipulation was exacerbated by genuine supply problems. A drought in the Pacific Northwest reduced the availability of cheap hydropower imports, an economic boom in Silicon Valley drove up demand, and not enough new power plants had been built within California to keep pace.

The Crisis

In the summer of 2000, the system broke. Wholesale electricity prices skyrocketed, climbing an astonishing 277% in a single year. Caught in the price vise, PG&E and SCE hemorrhaged cash, racking up billions in debt before PG&E ultimately declared bankruptcy in April 2001.

To keep the grid from collapsing entirely, the state operator was forced to institute “rolling blackouts,” plunging millions of homes and businesses into darkness. The state government had to intervene, spending billions of public dollars to buy emergency power on long-term contracts at the peak of the price bubble.

The California crisis was not a failure of deregulation in principle, but a catastrophic failure of deregulatory design. The state’s hybrid model, which attempted to combine the price volatility of a free market for suppliers with the price stability of a regulated system for consumers, was fundamentally unstable.

By creating a market architecture riddled with perverse incentives, policymakers inadvertently set the stage for one of the most costly and disruptive deregulation failures in U.S. history.

The Great Recession: The 2008 Global Financial Crisis

The 2008 financial crisis, the most severe economic downturn since the Great Depression, was the product of a complex web of factors. At its core, however, were two distinct but related threads of financial deregulation that unfolded over the preceding decade: the dismantling of long-standing barriers between different types of banking, and, more critically, the willful failure to regulate a new generation of complex and opaque financial instruments.

The Repeal of the Glass-Steagall Act (1999)

For over 60 years, the Banking Act of 1933, commonly known as the Glass-Steagall Act, created a firewall between commercial banking (the business of taking deposits and making loans) and investment banking (the riskier business of underwriting and selling securities).

The law was a direct response to the speculative abuses that were seen as a cause of the Great Depression, and it was designed to prevent banks from gambling with federally insured depositor money.

Over the decades, this wall was gradually eroded by regulators and court decisions. In 1999, Congress formally dismantled it by passing the Gramm-Leach-Bliley Act, which repealed the key affiliation restrictions of Glass-Steagall. This allowed for the creation of massive “financial holding companies” – universal banks that could combine commercial banking, investment banking, and insurance services under one corporate roof.

The role of GLBA in the 2008 crisis remains a subject of intense debate.

Critics argue that the repeal was a crucial contributor. They contend that it allowed a risk-obsessed, speculative culture from Wall Street to infect the more conservative culture of commercial banking. It also fueled the creation of financial behemoths that were “too big to fail,” meaning their collapse would pose a systemic threat to the entire economy, creating a moral hazard that encouraged even more risk-taking.

Defenders argue that GLBA’s role was minor at best. They point out that many of the institutions at the heart of the crisis – such as the pure investment banks Lehman Brothers and Bear Stearns, and the insurance giant AIG – were not commercial banks and would not have been constrained by Glass-Steagall. They maintain that the true root of the crisis was not the structure of banks, but the explosion of subprime mortgage lending and the subsequent collapse of the housing market.

The Deregulation of Derivatives (2000)

A more direct and widely accepted cause of the crisis was the explicit deregulation of a vast and shadowy corner of the financial world. The Commodity Futures Modernization Act of 2000, passed with little debate, effectively banned federal regulation of most over-the-counter derivatives.

This single act unleashed an unprecedented explosion in exotic and unregulated financial instruments, most notoriously Credit Default Swaps and Collateralized Debt Obligations.

A CDS is essentially an insurance policy, a side bet on whether a company or a security will default. A CDO is a complex product created by bundling together thousands of individual debts (like mortgages) and selling slices of that bundle to investors.

The CFMA turned this market into a global casino. Financial institutions like AIG sold trillions of dollars’ worth of CDSs, many of them insuring risky CDOs packed with subprime mortgages, without having to post collateral or prove they had the capital to pay out if the bets went bad.

This entire market, with a notional value that swelled to an estimated $600 trillion, operated in the dark. It was completely unregulated and opaque, with no central exchange and no way for regulators or even the participants themselves to know the true extent of the risk or who was exposed to whom.

When the U.S. housing bubble burst and subprime mortgages began to default en masse, the value of these derivatives plummeted. AIG, which had insured a massive volume of this toxic debt, faced catastrophic losses it could not cover.

Because AIG was the counterparty to nearly every major bank in the world through this intricate web of CDSs, its imminent failure threatened to trigger a domino effect that would have collapsed the entire global financial system. This forced the U.S. government to execute a massive, $180 billion bailout.

The 2008 crisis offered a profound lesson: financial “innovation,” when it dramatically outpaces regulation, can create new, poorly understood, and invisible forms of systemic risk. The catastrophe was not just a failure of removing old rules, but a complete failure to write new rules for a new and dangerously complex reality.

A Modern Disaster: The East Palestine Train Derailment (2023)

The fiery derailment of a Norfolk Southern freight train in East Palestine, Ohio, on February 3, 2023, provides a contemporary case study on the nuanced relationship between a specific mechanical failure and the broader regulatory environment that shapes safety culture and risk management in a critical industry.

The Incident and Official Cause

The derailment involved 38 cars, 11 of which were tank cars carrying hazardous materials like vinyl chloride and butyl acrylate. The National Transportation Safety Board, the federal agency that investigates major transportation accidents, conducted a meticulous investigation and determined that the probable cause was a failed wheel bearing on the 23rd railcar.

The bearing overheated to a critical temperature, causing the axle to fail and separate from the car, triggering the derailment.

The Broader Regulatory Debate

While the proximate cause was a mechanical part, the incident immediately ignited a national debate about whether years of relaxed safety regulations and industry practices had set the stage for such a disaster. Several key issues came under scrutiny.

Wayside Defect Detectors: The NTSB found that the system of “hot bearing detectors” along the track – designed to spot overheating bearings – failed to provide the train crew with an adequate warning in time to stop the train safely.

The NTSB noted that the 20-mile spacing between the final two detectors was too great and that Norfolk Southern’s own internal criteria for what temperature triggered a critical alarm were not stringent enough. Critics argue that the lack of federal standards for detector spacing and alarm thresholds represents a significant regulatory gap.

Braking Systems: The derailment brought renewed attention to a long-simmering debate over braking technology. A rule requiring trains carrying certain hazardous materials to be equipped with more advanced Electronically Controlled Pneumatic brakes, which can stop trains more quickly and evenly, had been finalized during the Obama administration but was repealed in 2018 by the Trump administration’s Department of Transportation, following intense lobbying by the rail industry.

While the NTSB did not conclude ECP brakes would have prevented the derailment, many safety advocates argue they could have significantly reduced its severity by stopping fewer cars from piling up.

Tank Car Standards: The NTSB’s investigation highlighted the poor performance of older DOT-111 tank cars. The post-derailment fire that ultimately led to the controversial “vent and burn” decision likely began when several of these cars, carrying flammable liquids, were breached.

The NTSB has for years identified these cars as having an “unacceptable safety record” and has repeatedly called for their accelerated phase-out in hazardous materials service.

The “Vent and Burn”: A Failure of Corporate Oversight

One of the most stunning findings from the NTSB’s investigation concerned the decision to intentionally breach five tank cars of vinyl chloride and burn off the contents, an action that created a massive, toxic chemical plume over the town.

The NTSB concluded that this “vent and burn” was unnecessary. The decision was made by the local incident commander based on “incomplete and misleading information” provided by Norfolk Southern and its contractors, who created an “unwarranted urgency” by claiming the cars were at imminent risk of a catastrophic explosion.

In fact, the chemical’s shipper, Oxy Vinyls, had data showing the cars were cooling and stabilizing and had advised Norfolk Southern that the procedure was not needed, but this information was not relayed to the decision-makers.

The East Palestine disaster illustrates that a single accident cause is often nested within a larger system of risks shaped by regulatory philosophy and industry practices.

The debate extends beyond any single rule to the overall safety culture fostered – or weakened – by the prevailing regulatory framework. This includes the industry’s widespread adoption of Precision Scheduled Railroading, an operating model that prioritizes efficiency by running fewer, longer, and heavier trains with smaller crews, which critics argue compromises safety margins.

The NTSB’s finding on the “vent and burn” also points to a dangerous failure of oversight in a live crisis, suggesting that in a loosely regulated environment, the company responsible for a disaster may wield too much influence over the response, potentially prioritizing its own liability and operational concerns over public health and safety.

Key Lessons from a Deregulated Past

The historical case studies reveal recurring patterns of failure. When deregulation goes too far or is poorly designed, it can unleash powerful and destructive forces. Understanding these forces – systemic risk, regulatory capture, moral hazard, and flawed design – is crucial for crafting effective and safe economic policy.

Systemic Risk: When One Failure Threatens the Whole System

Systemic risk refers to the danger that the failure of a single entity or a disruption in one part of a market can trigger a chain reaction, leading to a cascading collapse across the entire system. It’s a risk born of interconnectedness, where the failure of one institution can have devastating consequences for others that appear to be unrelated.

The 2008 financial crisis is the ultimate modern example of systemic risk. The initial problem was confined to a specific market: U.S. subprime mortgages. However, through the process of securitization and the use of unregulated derivatives like Credit Default Swaps, the risk from those mortgages was sliced up, repackaged, and sold to financial institutions across the globe.

When the mortgages began to fail, the entire, intricate web of connections began to unravel. The impending collapse of AIG, a company whose stability was linked to countless other banks through CDS contracts, threatened to bring down the whole system, demonstrating how deregulation of the derivatives market had created a hidden and catastrophic level of interconnectedness.

Similarly, the S&L crisis showed systemic risk within a single sector, as the widespread failure of thrifts threatened to bankrupt the federal insurance fund that backed the entire industry.

The lesson is clear: deregulation, particularly in finance, can create or obscure complex interdependencies that are invisible during good times but become powerful channels of contagion during a crisis.

Regulatory Capture: When the Watchdogs Work for the Watched

Regulatory capture is a form of government failure that occurs when a regulatory agency, which is supposed to act in the public interest, instead comes to advance the commercial or ideological interests of the very industry it’s charged with overseeing.

This doesn’t necessarily involve overt corruption – it can happen subtly through close relationships, lobbying, the revolving door of personnel between industry and government, and an agency’s reliance on the industry for data and expertise.

Capture can manifest in several ways. It can lead to the passage of flawed deregulatory schemes that benefit the industry at public expense. The California electricity crisis is a prime example, where energy companies like Enron heavily lobbied for the specific, flawed market design that they later ruthlessly exploited.

Capture can also lead to weak enforcement and excessive deference to industry, as seen in the S&L crisis, where the Federal Home Loan Bank Board was widely seen as too close to the thrift industry, leading it to practice forbearance and weaken capital standards rather than shut down failing institutions.

A more recent and alarming example comes from the East Palestine derailment. The NTSB’s finding that Norfolk Southern provided misleading information that led to the unnecessary “vent and burn” suggests a form of capture in a live emergency, where the entity causing the problem exerted undue influence over the response, to the potential detriment of public health.

The lesson is that the push for deregulation can itself be a product of regulatory capture, and a deregulated environment can dangerously empower captured industries.

Moral Hazard: The Danger of (Perceived) Safety Nets

Moral hazard describes a situation in which one party gets involved in a risky event knowing that it’s protected against the risk and some other party will incur the cost. It creates a perverse incentive to behave more recklessly than one otherwise would, precisely because the potential negative consequences are borne by someone else.

In the context of deregulation, government backstops are a primary source of moral hazard. The S&L crisis provides the clearest example. The existence of federal deposit insurance, which guaranteed all deposits up to $100,000, meant that S&L owners could take huge risks with other people’s money.

If their speculative bets paid off, they kept the profits. If the bets failed, the government-backed FSLIC would cover the losses. This “heads I win, tails you lose” scenario was a direct creation of the interaction between deregulation (which allowed risky investments) and the government safety net (which removed the risk for depositors and owners).

A similar dynamic was at play in the 2008 crisis. The implicit belief that the nation’s largest financial institutions were “too big to fail” and would be bailed out by the government in a crisis created a powerful moral hazard. It encouraged these firms to take on excessive leverage and risk, confident that they would be rescued if things went wrong.

The lesson is that safety nets, if not properly designed and priced to reflect risk, can have the paradoxical effect of encouraging the very behavior they’re meant to protect society against.

The Devil in the Details: The Risks of Flawed or Partial Deregulation

History shows that deregulation isn’t a simple on/off switch. The specific design of a deregulatory scheme, the sequencing of its implementation, and its incompleteness can be the difference between success and disaster. A poorly architected market can be far more dangerous than either a fully regulated one or a truly free one.

The California electricity crisis is the quintessential example of a flawed design. The state created a hybrid system that combined the worst features of regulation and deregulation: utilities were exposed to the full volatility of an uncapped wholesale market while being forced to sell at a capped retail price, a fundamentally unstable architecture.

The S&L crisis is a classic case of partial or incoherent deregulation. Policymakers freed the asset side of the S&Ls’ balance sheets, allowing them to make risky investments, but failed to reform the liability side, leaving in place the risk-distorting mechanism of flat-rate deposit insurance.

The lesson is that how an industry is deregulated is as important, if not more so, than whether it’s deregulated.

These concepts aren’t isolated – they often form a dangerous, self-reinforcing cycle. Regulatory capture can lead to the creation of a flawed deregulatory scheme that benefits a specific industry. That flawed scheme, especially if it includes government guarantees, can create a massive moral hazard.

Driven by this moral hazard, institutions take on huge, interconnected risks, which become hidden in opaque, unregulated markets. This creates systemic risk. When the system finally teeters on the brink of collapse, the government is often forced to intervene with a bailout, which rescues the industry and reinforces the moral hazard for the next cycle, setting the stage for a future crisis.

The Debate Today: Applying Historical Lessons to Modern Regulation

The lessons learned from these historical failures aren’t relics of the past. They provide an essential framework for understanding and navigating the most pressing regulatory debates of the present day, from the rise of artificial intelligence to the challenges of climate change and the future of the American workplace.

The Digital Frontier: Regulating AI and Big Tech

The rapid development of artificial intelligence and the immense power of large technology companies have sparked a fierce debate over regulation. One prominent view, particularly in a pro-business environment, is to adopt a “develop first, regulate later” approach to avoid stifling innovation.

This is often coupled with proposals for a federal moratorium on state-level AI regulations to prevent a patchwork of rules. At the same time, there are bipartisan calls for more active regulation of social media platforms, particularly concerning content moderation and the legal liability shield provided by Section 230 of the Communications Decency Act.

The lessons from financial deregulation offer a cautionary perspective on this debate.

The Lesson of 2008 and Unregulated Innovation

The 2008 crisis was not primarily caused by the deregulation of known activities, but by the complete failure to regulate new, complex, and opaque financial instruments like derivatives. The argument that regulation would “stifle innovation” allowed a $600 trillion shadow market to grow, creating systemic risks that no one fully understood until it was too late.

This history raises a critical question for today: Is the rapid, largely unregulated development of powerful and often opaque AI models creating a new form of systemic risk? Whether through the potential for AI-driven financial crashes, the mass dissemination of sophisticated disinformation, or other unforeseen consequences, the parallel to the unchecked growth of derivatives is a stark warning against assuming that innovation is inherently benign.

The Lesson of Airline Consolidation

The history of airline deregulation shows that in network-based industries, a hands-off approach can lead to immense market concentration, where a few dominant players control the landscape.

A “develop first, regulate later” approach to AI could similarly entrench the power of the handful of tech giants that currently control the data, computing power, and talent needed to build leading-edge AI systems, potentially limiting future competition and innovation.

The Environmental Equation: Air, Water, and Climate Rules

Environmental regulation is another major front in the modern deregulatory push. Citing the need to lower costs for families and “unleash American energy,” recent initiatives have targeted a wide range of Environmental Protection Agency rules for repeal or revision.

These include greenhouse gas emission standards for vehicles and power plants, standards for mercury and air toxics, and even the foundational 2009 “Endangerment Finding,” which provides the legal basis for the EPA to regulate greenhouse gases as pollutants under the Clean Air Act.

The lessons from history provide a critical lens through which to view this debate.

The Lesson of Externalities

At its core, much of environmental regulation exists to address “externalities” – costs, such as pollution, that a business’s activity imposes on society but that the business doesn’t pay for itself.

The debate over repealing EPA rules is fundamentally a debate about who should bear these costs. A deregulatory approach effectively shifts the burden from the industries that produce pollution to the public, which experiences the consequences in the form of increased health problems, environmental degradation, and the long-term impacts of climate change.

The Lesson of California’s Complexity

The California electricity crisis is a powerful reminder that energy policy is incredibly complex and that simplistic solutions can have catastrophic, unintended consequences.

Rolling back federal environmental standards in favor of “cooperative federalism” could create a chaotic patchwork of differing state rules, leading to legal challenges and profound uncertainty for both industry and the public. This echoes the dangers of a poorly designed system, where the removal of one set of rules without a coherent replacement can lead to market instability and negative outcomes.

The American Workplace: Labor Standards in Flux

The rules governing the American workplace are also a key area of deregulatory focus. The Department of Labor has proposed rewriting or repealing dozens of workplace regulations, including rules that extend federal minimum wage and overtime protections to home health care workers.

The stated justification is that such deregulation would lower labor and compliance costs for employers, potentially expanding the market for these services.

This debate brings to the forefront some of the oldest questions surrounding regulation.

The Lesson of the Progressive Era

The very history of government regulation in the United States began in the late 19th and early 20th centuries as a response to the abuses of a largely deregulated Gilded Age economy. Laws establishing minimum wages, workplace safety standards, and the right to organize were created to protect workers and consumers from the harsh realities of a market where they had little power.

The current debate over rolling back labor standards is a modern iteration of this century-old tension between business efficiency and worker protection.

The Lesson of Uneven Distribution

Just as airline deregulation created clear winners (travelers in major hubs) and losers (travelers in small towns), labor deregulation may also distribute its costs and benefits unevenly.

Lowering costs for home care agencies may benefit those businesses and potentially some clients, but it comes at the direct expense of the workers themselves – a workforce that’s disproportionately composed of women and minorities.

This raises the fundamental question that underlies all deregulatory efforts: Who benefits, who pays the price, and is the trade-off worth it?

The Path Forward

The historical record of deregulation in America reveals a complex story that defies simple narratives. Neither a blanket endorsement nor a wholesale rejection of deregulation is supported by the evidence. Instead, the case studies demonstrate that the devil is truly in the details.

Successful deregulation requires careful attention to market design, adequate safeguards against systemic risk, and mechanisms to prevent regulatory capture. It also requires honest acknowledgment that the benefits and costs of deregulation are rarely distributed evenly across society.

The airline industry provides a useful example. While deregulation delivered substantial benefits to many travelers, it also created new problems for smaller communities and specific populations like emergency patients. Recognizing these trade-offs allows for more nuanced policy responses, such as the Essential Air Service program or efforts to address air ambulance billing.

As policymakers grapple with modern challenges like artificial intelligence, climate change, and the evolving workplace, the lessons from past deregulatory experiments offer valuable guidance. The key is learning from both the successes and failures of the past to craft policies that harness the benefits of market forces while protecting the public interest.

The goal shouldn’t be deregulation for its own sake, but rather the creation of regulatory frameworks that are effective, efficient, and fair. Sometimes that means removing outdated rules that stifle innovation and competition. Other times it means creating new rules to address emerging risks and protect vulnerable populations.

The challenge for democratic societies is finding the right balance – enough regulation to prevent the worst excesses of unfettered markets, but not so much that it stifles the innovation and competition that drive economic progress. History shows that getting this balance right requires vigilance, adaptability, and a willingness to learn from both success and failure.

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