Don't Blame Deregulation For This Crisis, It's All About Lack of Regulation

Sebastian Mallaby says deregulation is not the cause of the financial crisis. Jamie Galbraith would disagree (more direct disagreement here and here):

Goodbye, Conservatives. Hello, Predators, by James K. Galbraith: Back in the Reagan days, Republicans talked economics. We had problems; they had solutions. Tight money would cure inflation. Low taxes would stimulate saving and hard work. Small government would "crowd in" investment; free trade would make us efficient.

Smart people believed this, and they had Milton Friedman to back them up. I never thought they were right-but they were serious. They were coherent. And they argued with passion and conviction, which commanded respect.

But now, real economic conservatives have disappeared from the Republican stage. ... Bush is a bread-and-circuses reactionary with a clientele of lobbies. McCain gets his economic ideas from Phil Gramm, the ultimate architect of the Enron culture, of libertine speculation and financial disaster. ... This crowd deregulates and privatizes not because they think it might work out for the public... What they care about is putting their friends in charge.

Under Bush, oil and gas, drug companies and defense contractors, insurers and usurers, banks and big media control the government of the United States. John McCain..., as chair of the Senate commerce committee,... presided over Lobby Central; notoriously, his campaign is run by lobbyists ... and until last week his policy could be summed up in slogans: he was a "free market" man, a "deregulator." ... Bush and McCain are the predator state writ large...

On the morning that Lehman Bros. (LEH) and Merrill Lynch (MER) fell,... the ... Dow Jones average fell 504 points... As stocks crashed, suddenly people remembered that modern markets cannot exist without a cop on the beat. Every important market out there, from fresh food and safe drugs to autos and air travel to housing and health care, depends on government to maintain trust, and without it, none of them would survive. Without regulation, predators take over, and when they do, trust eventually collapses. Every important market is in peril now, precisely because of the predators in power these past eight years. And none more immediately than finance.

The Bush-Paulson bailout exposed the predator state in detail. Deregulation and desupervision were the origin of this crisis: the 1999 Gramm-Leach-Bliley Act repealing Glass-Steagall, and the Gramm-authored loophole legitimating credit default swaps in 2000. Bush's financial regulators brought chainsaws to press conferences, a clear signal to sub-prime hustlers that "anything goes." "Liar's loans," "neutron loans" and "toxic waste" became financial terms of art. ...

It seems unlikely that John McCain, the regulation-wrecker, will become, overnight, the man who would turn vice to virtue on Wall Street. But even suppose he were serious. Who would trust him? No one with money on the line.

This is McCain's deeper problem. If he is elected, under his leadership, trust cannot be restored. ... Restoring trust requires a government of trustworthy people. Team McCain doesn't have any, and some, especially Gramm, inspire the opposite. It wouldn't matter what their policies were or pretended to be. Nothing they attempted would work.

The ... choice in this election is well-defined. One party believes that the government serves no public purpose. The other believes that it must. One party has turned the government over to lobbies, to cronies and to big donors. The other is beginning to realize that a real government must be rebuilt. One party would keep the same crowd in office; the other would have to begin by clearing them out. No one can say there is no difference between the parties this year, and the basic issue in this election is really just as simple as that.

I thought the best part of Sebastian Mallaby's article came when he provided this link: "There's a vigorous argument about whether Calomiris's number is too high." As to his main argument, "that deregulation is the wrong scapegoat," I don't think it was deregulation of any particular sector that caused the problems we are having in credit markets, I think it was lack of effective regulation of the shadow banking sector in general (i.e. the regulations that did exist in the shadow banking sector were not directed at the right issues, thus, it's possible to believe, as I do, that some of the deregulation was warranted while still believing that needed regulation was missing).

The shadow banking sector should be under the same regulatory umbrella that traditional banks are subject to, and extended the same sorts or privileges within the Federal Reserve system in return (deposit insurance of some type, and lender of last resort functions in return for regulatory restrictions). There is no guarantee this would have stopped the credit crisis from developing, but I don't think the conclusion we should draw from the present experience is that these markets weren't free enough.

Hopefully, we can use what we've learned as the crisis has unfolded and also use what we've learned from regulating the traditional banking sector to devise a regulatory structure that will improve the stability of credit markets.

Comments

[css1971:]

And yet... The government is regulating 700 billion into the pockets of these people... That doesn't sound like a lack of regulation to me. It sounds like a whole lot of regulation.

Would you like to know what would really happen with a lack of regulation? They would collapse. The lot of them. They would dissolve in the toxic mess they had created and people would be just a little more wary of trusting sharks with their money because they know the nice government men aren't going to step in and save them from their own folly.

In a truly deregulated market, trust and reputation would have to be earned... and would be worth it's weight in gold.

2008 Oct 07 04:35 PM

[HARM:]

There is a *huge* difference between true "regulation" and "taxpayer corporate subsidies".

Examples of true business regulation that is actually *beneficial* to the average taxpayer and consumer:

Slavery outlawed
Child labor laws
Anti-racketeering laws
Anti-Trust laws
Anti-discrimination/in... laws
Anti-pollution laws
OSHA/worker safety laws
FDA food safety inspections

Examples of NON-regulation corporate handouts ("socialism for the rich") frequently mistaken for actual regulation:

TARP
Bear-Stearns/AIG bailouts
Nationalization of Phonie & Fraudie
Fed's 2% (soon to be 1% or 0%)
MID for non-owner-occupied flip houses, HELOCs and cash-out refis

2008 Oct 07 06:14 PM

[village obsrvr:]

It seems to me less to be a problem of lack of regulation. The wrong kind of intervention has caused much of the problems in this market - the federal government protecting lobbyist donors. There is way too much conflicting interest on Capitol Hill.

2008 Oct 07 10:33 PM

[taxed2much:]

For readers who had a hard time following this article and who was writing what, here's part of the article mentioned but left out. Giving me and probably every reader the strong feeling of bias writing by the author. I must say I am biased to the facts presented in the article left out because when I ask myself who was doing the regulating, and who is in charge of the whole show? It is the Democrats. They control both houses of Congress with an iron claw. The banking and finance committe is largely democrats and the chair is Barney Frank. Pelosi won't allow anything Republican party oriented to the floor in the House and won't allow voting on anything of substance that has even a chance of getting through appropriations. She is good at renaming post offices and real needed other legislation like what? the bailout passage that every person with half a brain knew would do nothing to save the markets. How anyone can think having the orchestrators of the mess try to orchestrate its fix using the same methods that caused the problems is beyond me. I just do not understand why the people in this country will not stand up and shake the living crap out of the politicians in office. This problem is one thing that the media has called right when they say it is about greed. They just never mention the greed orchestrators who are supposed to be regulating the whole banana. Less regulation and more consequence for the ones causing mine and yours financial independence to disappear in the matter of days is unacceptable and those in the seats of charge should be held accountable with severe punishment, fines, jail time, and restitution, oh and reform classes when they do get out of jail. These people are no less than a common thief who steals from the corner store or breaks into a residence to burglarize for self gain. Same result to the homeowner or business owner-they have some of their wealth stolen. The regulators wrote the laws to their own advantage and got caught up in the greed it generated. They are all beyond wealthy, the ones who are for the bailouts and farcicle regulatory agencies and policies. The ones who are not been for the bailouts had their arms twisted when the greased palm was not enough. Stand up and vote them out of office since the legislators will never punish the regulators who of course are one and the same. Now that part of the article aforementioned:

Rather, the key financiers were the ones who bought the toxic mortgage products. If they hadn't been willing to buy snake oil, nobody would have been peddling it.

Who were the purchasers? They were by no means unregulated. U.S. investment banks, regulated by the Securities and Exchange Commission, bought piles of toxic waste. U.S. commercial banks, regulated by several agencies, including the Fed, also devoured large quantities. European banks, which faced a different and supposedly more up-to-date supervisory scheme, turn out to have been just as rash. By contrast, lightly regulated hedge funds resisted buying toxic waste for the most part -- though they are now vulnerable to the broader credit crunch because they operate with borrowed money.

If that doesn't convince you that deregulation is the wrong scapegoat, consider this: The appetite for toxic mortgages was fueled by Fannie Mae and Freddie Mac, the super-regulated housing finance companies. Calomiris calculates that Fannie and Freddie bought more than a third of the $3 trillion in junk mortgages created during the bubble and that they did so because heavy government oversight obliged them to push money toward marginal home purchasers. There's a vigorous argument about whether Calomiris's number is too high. But everyone concedes that Fannie and Freddie poured fuel on the fire to the tune of hundreds of billions of dollars.

So blaming deregulation for the financial mess is misguided.

2008 Oct 07 10:37 PM

[taxed2much:]

Above where I wrote less regulation is unacceptable I meant to say that less regulation is needed and more punishment of the harsher variety is needed. Sorry to confuse.

2008 Oct 07 10:47 PM

[john s. gordon:]

AIG & deregulation - no more golden parachute parties funded by the taxpayer.
> jack

2008 Oct 08 08:08 AM

[martyg:]

regulation and step # 1 is working wonderfully as of today.
no short selling in financial stocks permitted? what a wonderful positive result so far.

2008 Oct 08 09:33 AM

[John Lounsbury:]

Come on, folks. Too many people are trying to blame one political viewpoint and absolve another. STOP BEING RIDICULOUS!!!!!

This mess was created with the advice and consent of both political parties and flawed economic models. Let's get over it and start figuring out a new paradigm.

2008 Oct 08 10:56 AM

[carey_jim:]

Regulation itself is subject to corruption.

(Almost) perfect regulation ends with referees on the sports field but even referees have been known to accept bribes or have very bad days.

Society tries to regulate crimes by threatening dire punishments (the United States penal system) but with only moderate success.

You can try to stop men and women from selling their bodies on the streets but it is almost impossible to prevent them from selling themselves in the market place.

Greed distorts everything, including our sense of fair play.

Dancing around the golden calf is, apparently, irresistible, whatever Moses or anyone else has to say about it.

2008 Oct 08 12:24 PM

[kingaj12:]

The blogosphere is not paying enough attention to the point that there were so many willing buyers and sellers of subprime ABS paper, regulation or no regulation.
This point has been addressed by a couple of academic papers:
-- S. G. Ryan, NYU Stern School: Accounting in and for the Subprime Crisis (March 2008)
-- M.G. Crouhy, R.A. Jarrow and S.M. Turnbull: The Subprime Credit Crisis of 07 (July 2008)

Both are available from www.ssrn.com.

These papers make the point that while traders were binging on the arbitrage between AAA and BBB subprime ABS tranches, the credit agencies themselves were implicitly producing a pro-cyclic effect by relaxing collateral during times of high House Price appreciation (HPA) and tightening during low HPA. The 20 Case-Schiller Index shows a significant difference between the last cycle (80's to mid-90's) and the current one.
www2.standardandpoors....

2008 Oct 08 01:59 PM

[candooman:]

Until the Community Reinvestment Act was passed by the Democratic Congress, signed by Carter 1977 and given more teeth by Clinton in 1999, the decades old banking practice of requiring proof of ability and reliability to pay a morgage back worked very well. The was no need for regulations. The Democrats desire to bring their poor constituents started all this mess that we are now all paying for.

2008 Oct 08 02:06 PM