Deregulation did not Cause Financial Crisis, Welfare Did
"The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Henry Hazlitt – Economist/Journalist (1894 – 1993) by Kenn Jacobine
Saturday, September 18, 2010
If only Alan Greenspan, George Bush, and the rest of the economic imbeciles in Washington that gave us the Great Recession would have heeded the words of the great Henry Hazlitt, as a nation we would not have produced so much phony wealth which in turn has caused so much pain. Leftist wholeheartedly support this view. As a matter of fact, the current occupier of the Oval Office is fond of constantly reminding Americans that it was George Bush and his Republican Congress from 2001 to 2006 that implemented the policies that caused the worst financial and economic crisis since the Great Depression. But, while Obama and the left are correct about who caused the crisis they are way off the mark about what the guilty parties actually did to bring it about.
Obama and his ilk claim the cause of our current troubles was the deregulation of the financial services industry in the late 1990s and early 2000s. Now, they have to be careful because the major deregulation legislation of this time frame was signed by one their own "“ President Bill Clinton. I am of course referring to the law which repealed the Glass/ Steagall Act. Enacted during the Great Depression, Glass/Steagall prohibited commercial banks from owning investment banks, and vice versa. It was meant to safeguard commercial banks against failure by making it illegal for them to participate in investment bank practices like securities trading and stock and bond underwriting.
It does seem more than coincidental that the most severe economic crisis since the Great Depression has taken place shortly after the repeal of Glass/Steagall. And to the shallow statist mindset that is all that matters. But Obama and the left are wrong; repeal of Glass/Steagall did not cause the current financial crisis. In the first place, as Conn Carroll of the Heritage Foundation has pointed out, Glass/Steagall was "steadily weakened" from the 1970s on by the "complex new financial reality" of the times and by waivers from regulators that made mergers routine - the 1998 merger between Travelers and Citigroup essentially repealed the law once and for all. Thus, the erosion of the law over 30 some years without any major financial crisis is an indication that the ultimate repeal of what was left of the law in 1999 did not cause the troubles of today.
Next, by looking at which institutions brought on the financial carnage one can conclude that Glass/Steagall's repeal was inconsequential. Bear Stearns, Lehman Brothers, and Merrill Lynch all went belly up as investment banks without commercial bank divisions. The granddaddy of them all, AIG is an insurance company with no commercial banking division. Washington Mutual was a savings bank that went bankrupt because of the many sub-prime mortgage loans it made that went bad. Lastly, Fannie Mae and Freddie Mac did not fall under the jurisdiction of Glass/Steagall and their bailouts are on target to hit $1 trillion at the rate home prices continue to fall. So in reality Glass/Steagall would not have prevented any of these firms from causing so much trouble for the economy. Further, it has been argued with a lot of validity that the repeal of Glass/Steagall has actually benefitted taxpayers in this crisis. It has reduced their losses that would have been incurred by direct government bailout by allowing Bear Stearns to be purchased by JPMorgan Chase and Merrill Lynch to be scooped up by Bank of America. All things considered equal, the repeal of Glass/Steagall has been a blessing in disguise for our economy.
Lastly, it is ridiculous to believe that the repeal of Glass/Steagall would cause bankers and investors to become so reckless and irresponsible with their resources that they would risk their economic viability. It just wouldn't happen. Knowing that they could lose everything, their robust salaries and benefits, personal wealth, good name of their companies, and their own professional reputations most CEOs take great care to honor the fiduciary responsibilities they are given.
But, some obviously do not. As we have seen it was not on account of the repeal of Glass/Steagall. Those that gambled with others' money to get rich quick did it because of statist government policy not libertarian deregulation.
The simple fact is that the Great Recession was caused solely by irresponsible welfare policies of Washington. These welfare policies specifically targeted homeowners and banks. Undeterred by the dot.com bubble and ultimate crash he caused in the 1990s, Alan Greenspan kept interest rates too low for too long again in the early 2000s after 911. At the same time, President Bush stated that he was about to "use the mighty muscle of the federal government" to make homeownership more available for more Americans. He got Congress to spend up to $200 million a year to assist first-time homebuyers with down payments. He pressured mortgage lenders to make sub-prime loans because "Corporate America has a responsibility to work to make America a compassionate place." Lastly, he caused immense moral hazard by getting Fannie and Freddie to guarantee all the junk loans being made, again to the tune of potentially $1trillion.
When Bush, Greenspan, and their legislative accomplices on the Hill launched this massive welfare program for banks and homebuyers after 911, they did not take into account the words of Henry Hazlitt. They only considered the immediate effects for two groups in society. Even years later, when Bernanke and Paulson informed the president of the enormous economic catastrophe that our country was about to face and they pressured him to sign off on government bailouts for their banking buddies, Bush was said to have remarked "How did we get here?"
We got here because of government intervention into the economy not deregulation. Unfortunately we are going to stay here because Obama is doing exactly what Bush did before him "“ provide cheap money and encourage borrowing through government funding (tax credits for first time homebuyers) and guarantees. Maybe that is why Obama and the left are so keen to blame deregulation for the crisis. They use it as a smokescreen to hide the failures of the welfare state in the past and the failures we will experience in the future.
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Posted By: Bentree
Date: September 27, 2010 06:43:24 AM
I wrote this and posted it on Jon Taplin's blog at the time of Bear Stearn's demise. RIP
The Genesis of the housing bubble. Why did the Feds decided to bail out Investment firms? Is it because that’s where the government inspired bad paper ended up. Could it be that the government may be responsible for the creation of this bad paper? Why would banks loan money to individuals or business’s who can’t demonstrate the ability to repay? Why would they do that? Bankers may be a lot of things but crazy isn’t one of them. Wouldn’t you think the Government should encourage people to work, save their money and pay their bill’s thus showing the ability as well as the willingness to repay creditors, creating good credit? Sound too logical doesn’t it?
Enter the CRA, The Community Reinvestment Act, 1977. The stated purpose of the act was to “evaluate a depository institutions role in meeting the credit needs of the entire community”. It sounds relatively harmless? In short if lenders didn’t meet these needs they weren’t allowed to grow or even start a bank and after 1995 they subject to being fined. This meant they were coerced into making loans/mortgages to people who couldn’t demonstrate the ability to repay. I am aware of the reasoning behind this, depressed areas, red lining etc. So how do you loan money, for whatever the purpose, to people who have no ability to repay. It’s easy, interest only, subprime, No documentation, No verification of anything and any number of other variations of the rules in order to qualify them for the loan.
In effect the Congress created an irresponsible banking and mortgage industry in order to satisfy political correctness. Another one of the many intended/unintended consequences disrupting all our life’s, again brought to you by our Government.
In the 70’s & 80’s, IRS rules encouraged the run up of values in commercial real estate when people invested in the depreciation (deductibility) rather than the actual economic value of the property. Tefra changed those rules and this contributed to the downfall of the Savings and Loans. The collateral held by the Savings & Loans instantly was reduced by up to 30% and then some. In the long run Tefra encouraged a sounder economic basis for commercial valuation. Who knows what they will do about this. I don’t think “whoops” my bad will cut it.