Wednesday, December 10, 2008

is deregulation to blame?

Following up on Obama's claims about deregulation, a great article from Katherine Mangu-Ward in Reason on deregulation, wrongly, getting the blame for current messes...

In reality, regulation as a whole has thrived under President George W. Bush. Between 2001 and fiscal year 2009, the federal regulatory budget increased 65 percent in real terms, to about $17.2 billion. (For more see "Bush’s Regulatory Kiss-Off”.)

But what about Wall Street in particular? What specific acts of deregulation are being blamed for the financial crisis, and what role if any did they play? Let’s look at the accusations one by one:

1) The partial repeal of the Glass-Steagall Act in 1999 allowed commercial banks to get involved in risky investments, such as mortgage-backed securities.

In fact, multiple exemptions to Glass-Steagall had been granted for years before Gramm-Leach-Bliley was signed into law. Most European financial markets, not normally known as more “deregulated” than the U.S., never separated commercial and investment banks in the first place. And there is no correspondence between institutions that benefited from the repeal and those that recently collapsed....If anything, Gramm-Leach-Bliley may have softened the blow. The George Mason economist Tyler Cowen argues that Gramm-Leach-Bliley made way for more diversity in the financial sector...There is a significant body of academic work supporting this idea....

2) The Commodity Futures Modernization Act of 2000 guaranteed that high-risk tools such as credit default swaps remained unregulated...

...In other words: The absence of a regulation didn’t cause the crisis, but it may have exacerbated it. Part of the problem was a technicality. Instruments such as credit default swaps aren’t quite the same thing as futures, and therefore do not fall under the Commodity Commission’s purview. But the real issue was...the sight of important figures in the financial world publicly warring over the legality and appropriate uses of the derivatives could itself create dangerous instability....

3) A 2004 rule change by the SEC permitted big firms to keep too much debt on their balance sheets.

There is a sense in which the change was a deregulation. It did, after all, loosen a rule. But it did so in the context of what Adam C. Pritchard of the University of Michigan Law School calls a “rather Rube Goldberg apparatus for regulating financial services..." This is the kind of false, constrained deregulation that gives free markets a bad name.

It may have actually been a new regulation that kicked off the crisis. In 2007, the Financial Accounting Standards Board issued a statement about mark-to-market practices, FAS 157, clarifying the ways that publicly traded companies should value their assets....

4) Through all this time, Fannie Mae and Freddie Mac were allowed to run wild.

...they were regulated less than their fully private counterparts when it came to such crisis-impacting phenomena as derivatives trading and capital requirements. Because of their size and politicized culture, they were able to fend off periodic attempts at reform. And because of the government’s implicit (and eventually explicit) guarantees of their multi-trillion-dollar portfolios, they lacked the discipline of worrying about failure.

Letting Freddie and Fannie get away with murder wasn’t deregulation. It was bad governance. And letting deregulation take the primary blame for a credit-fueled housing bubble and its aftermath isn’t an argument. It’s misdirection.

2 Comments:

At December 11, 2008 at 4:45 AM , Blogger Unknown said...

If there is one thing that we know for sure about the current economic crisis it is that the controversy over what caused it will rage on for years.


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At December 11, 2008 at 6:36 PM , Blogger William Lang said...

My impression is that the problem is not so much that existing regulations were removed or relaxed, but that types of financial institutions not previously regulated grew to become a "shadow banking system" whose size exceeded the traditional, regulated banking system. These institutions were highly leveraged, and so they were very vulnerable to the shocks resulting from the housing bubble collapse.

 

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