Day By Day

Tuesday, September 30, 2008

The Credit Crisis

Democrats have been braying loud and long into every available media outlet that the cause of the credit crunch that is threatening us all is deregulation, usually described as "the failed economic policies of the Republicans." As Peter Wallison explains, this is sheer nonsense. I quote extensively:

The credibility of the charge depends on ignoring several important facts:

-- There has been a great deal of deregulation in our economy over the last 30 years, but none of it has been in the financial sector or has had anything to do with the current crisis. Almost all financial legislation, such as the Federal Deposit Insurance Corp. Improvement Act of 1991, adopted after the savings and loan collapse in the late 1980s, significantly tightened the regulation of banks.

-- The repeal of portions of the Glass-Steagall Act in 1999 -- often cited by people who know nothing about that law -- has no relevance whatsoever to the financial crisis, with one major exception: it permitted banks to be affiliated with firms that underwrite securities, and thus allowed Bank of America Corp. to acquire Merrill Lynch & Co. and JPMorgan Chase & Co. to buy Bear Stearns Cos. Both transactions saved the government the costs of a rescue and spared the market substantial additional turmoil.

None of the investment banks that got into financial trouble, specifically Bear Stearns, Merrill Lynch, Lehman Brothers Holdings Inc., Morgan Stanley and Goldman Sachs Group Inc., were affiliated with commercial banks, and none were affected in any way by the repeal of Glass-Steagall.

It is correct to say that there has been significant deregulation in the U.S. over the last 30 years, most of it under Republican auspices. But this deregulation -- in long-distance telephone rates, air fares, securities-brokerage commissions, and trucking, to name just a few sectors of the economy where it occurred -- has produced substantial competition and innovation, driving down consumer costs and producing vast improvements and efficiencies in our economy.

The Internet, for example, wouldn't have been economically possible without the deregulation of data-transfer rates. Inc., one of the most popular Internet vendors, wouldn't have been viable without trucking deregulation.

-- Republicans have favored financial regulation where it was necessary, as in the case of Fannie Mae and Freddie Mac, while the Democrats have opposed it. In 2005, the Senate Banking Committee, then under Republican control, adopted a tough regulatory bill for Fannie and Freddie over the unanimous opposition of committee Democrats. The opposition of the Democrats when the bill reached the full Senate made its enactment impossible.

Barack Obama did nothing; John McCain endorsed the bill in a speech on the Senate floor.

-- The subprime and other junk mortgages that Fannie and Freddie bought -- and the market in these mortgages that their buying spawned -- are the underlying cause of the financial crisis. These are the mortgages that the Treasury Department is asking for congressional authority to buy. If the Democrats had allowed the Fannie and Freddie reform legislation to become law in 2005, the entire financial crisis might have been avoided.

Read the whole thing here.

When asked to comment on the crisis Barak Obama lied and presented an analysis that was complete falsehood. Read Greg Mankiew's explanation here.

And then there is this from Harvard economist Jeffrey Miron:

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.

Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.

The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

Read the whole thing here.

On the other hand there is something to what David Brooks wrote in today's NYT:

We’re living in an age when a vast excess of capital sloshes around the world fueling cycles of bubble and bust. When the capital floods into a sector or economy, it washes away sober business practices, and habits of discipline and self-denial. Then the money managers panic and it sloshes out, punishing the just and unjust alike.

What we need in this situation is authority. Not heavy-handed government regulation, but the steady and powerful hand of some public institutions that can guard against the corrupting influences of sloppy money and then prevent destructive contagions when the credit dries up.

Read the whole thing here.

Certainly the immediate internationalization of capital flows brought on by the computer age has introduced a lot of instability into national economies, but is Brooks' call for "the powerful hand of public institutions" to regulate the flow of capital desirable.

Time after time, over the course of the past half century and more public officials and institutions have shown that they cannot be trusted. Corruption, incompetence, and most of all ideological zeal have perverted and undermined nearly every initiative undertaken by government. International agencies have performed even less well. It is for good reason that many Americans feel that the "powerful hand of public institutions" is far more to be feared than desired.

I am one of them.