Streetwise Professor

September 24, 2008

Regulate This

Filed under: Derivatives,Economics,Politics — The Professor @ 9:35 am

The emerging conventional wisdom about the ongoing financial crisis is that it was the result of too little regulation, and that additional regulation will be needed to prevent its recurrence. Just what regulatory lacunae caused the current crisis, and just what regulatory changes will save us from future scourges are almost always left unsaid. Instead the word “REGULATION” is wielded like some magic incantation, which by its very utterance will protect us.

Sorry. Not good enough. Details matter. Specifics matter. Talk to me when you have some of either. Until then, talk to the hand.

One accusation that I have seen is particularly risible. That is that the 1999 repeal of the Glass-Steagall Act (by the Gramm-Leach-Bliley Act) somehow caused the meltdown. Helllooo. This would be somewhat plausible if the securities underwriting affiliate of a commercial bank imploded, causing a bank failure that sparked a general banking panic. Nothing remotely like that happened. Indeed, the crisis erupted because the very institutions created by Glass-Steagall–stand alone investment banks–blew up. Indeed, the modern, post-’99 versions of universal banks, took hits, but survived. Moreover, the last big investment banks standing–Morgan Stanley and Goldman Sachs–are rushing to transform themselves into banks. Other investment banks have been sold off–or their corpses have been–to commercial banks. In other words, the market is throwing dirt on Glass-Steagall.

The single most important factors in the meltdown (as an oped by Calomiris and Wallis in today’s WSJ points out) were Fannie and Freddie. (Although I have long believed that Fannie & Freddie were disasters, I have not been convinced that their actions in the subprime market were essential to the proliferation of bad mortgage debt. The Caomiris-Wallis piece and other things I’ve read are persuading me that F&F were primus inter pares in causing the disaster.) Fannie and Freddie were not market failures. They were creatures of the government doing the bidding of a coalition of Congressmen. I agree wholeheartedly that they were not regulated properly or sufficiently. But you are truly delusional if you believe that’s what Congress or other bloviators mean when they call for “more regulation.” In fact, the very Congressmen that aided and abetted F&F are (a) doing their level best to perpetuate that scam as long as possible, and (b) using the financial fallout from the effects of F&F to justify the imposition of regulations on other financial institutions.

One of the great lessons of the Crash of ’29 and the Great Depression is that people learned the wrong lessons from the Crash of ’29 and the Great Depression, and created regulatory “fixes” to phantom problems. Glass-Steagall, the Securities Act, the Exchange Act, the Commodity Exchange Act, etc., were all responses to defective diagnoses of what caused the Crash and the subsequent depression. Each imposed substantial costs on the economy for decades afterwards, and didn’t address the real causes of the financial and economic tumult of the late-1920s and 1930s. I fear that history is in the process of repeating itself.

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