The Truth About Regulation and the Financial Crisis

I was trying to start an argument about the financial crisis. A person I know on the far left blamed deregulation. She has next to no knowledge of financial markets, and she is simply wrong on the record of deregulation under Bush. Without evidence she assumes two things:

1. Substantial deregulation of financial markets took place under Bush
2. This deregulation in large part caused the current financial crisis

I recently found a prescient article from the Wall Street Journal dated November 11, 2003.

Mr. Mankiw did taxpayers a service by wading into the debate over how to monitor these companies that have become repositories of enormous financial risk. Fannie in particular has marshaled its political troops to stop a bill in Congress that would transfer its regulation to the Treasury Department from a feckless unit of HUD. Fannie prefers feckless.

Specifically, "the subsidy creates a source of systemic risk for our financial system." This is because "the subsidy has allowed" the companies "to become gigantic," with their debt more than tripling to $2.2 trillion from 1995 to 2002."

Oh, but it gets better. "But especially notable is the support for Fannie and Freddie from liberals who normally detest corporate welfare. In this case, Congressman Barney Frank criticized Mr. Mankiw because he is worried about the tiny little matter of safety and soundness rather than "concern about housing."

Link to the article

For a problem as complicated as the financial crisis, it is not likely to be the only major cause. Looking at the evidence we see evidence that regulation was actually increased on Wall Street. The deregulation that did happen in the recent past probably prevented even worse consequences. One, Sarbanes-Oxley substantially increased the regulatory burden on companies. Under SarbOx, companies must mark certain assets to market. Even performing assets have been marked down substantially by banks. Since many of these assets are illiquid and difficult to value, they are often marked to a model rather than an actual market price(since a market price does not exist). Two, a substantial deregulation, the Gramm-Leech-Bliley Financial Services Modernization Act, enacted in 1999 under Clinton probably helped prevent an even worse disaster. This act repealed substantial parts of Glass-Steagall, and it allowed commercial banks and investment banks to combine. The universal banks have fared better in the recent crisis. I have a few more comments and links on another post.


I don't expect everyone to be an expert on regulation of financial markets. I certainly am not one myself. However, I do expect someone to actually have some facts about a situation before they argue a position. Remember, "Everyone is entitled to his own opinion, but not to his own fact"

I will continue to research this issue, and keep my readers updated.

Paulson

1. 

What to say

Lehman had its long slow, descent into bankruptcy. It makes you wonder why Bear and not Lehman. Part of it is that Bear failed first. The other is that Lehman's troubles were relatively well known for months and the market had time to absorb the news. If anybody else some better ideas, please comment.

We are seeing the 3 month treasury bond yield at near zero.
When the government can borrow for nearly free and a nominal basis and a negative real interest rate, it's not a good sign. You cannot help but think of Japan when you see the rates this low. There are some parallels, but the actions taken recently have been different than Japan in the 1990s. In Japan, bad banks were propped up by the government. At least the bailouts here seem to be designed so that the common stock holders do not receive much. I believe the goal of the recent bailouts is different than the bailouts in Japan. I hope the goal here is to assist an orderly liquidation of assets rather than to protect the older and established companies and to keep up appearances.

AIG received an $85 billion loan from the Fed in return for 80% of the equity. The Fed now has control over AIG. The effects of this are being felt by the financial markets today.
"Banks abruptly stopped lending to each other or charged exorbitantly high rates Tuesday, threatening to spread the troubles of American International Group Inc. and Lehman Brothers Holdings Inc. to a broad range of financial institutions and the global economy."

"The depth of the money-market problems became clear at lunchtime in London, when the British Bankers' Association published Tuesday's Libor borrowing costs. Every day, 16 banks report what it would cost them to borrow at certain maturities and currencies. Overnight dollar Libor soared to 6.4375% from 3.10625%, the largest jump on record. Three-month dollar Libor rose to 2.876% from 2.816%."

If you are relatively informed on the recent events, I'd enjoy having a conversation about it to see what you think.