Did Lack of Regulation Cause the Financial Crisis?

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Bill
Moyers recently interviewed William Black (ht Glenn Greenwald),
who is a regulator who came to fame for exposing the "Keating
5" Senators for their misdeeds during the Savings & Loan
crisis and wrote a book based on that experience called The
Best Way to Rob a Bank Is to Own One: How Corporate Executives and
Politicians Looted the S&L Industry.
The
interview
mostly covers our current financial crisis and is
well worth watching.

You
may recall that as the crisis initially unfolded, there was a reflexive
reaction on the part of many to blame deregulation, without presenting
any evidence for that position. Black makes numerous references
to a lack of regulation as being responsible for the mess, but does
bring up specific examples. Black quite naturally brings with him
the bias of a regulator, so it is necessary to examine what he says
in order to evaluate his assertions. I have summarized some of his
key points below, in the order in which they surfaced in the interview,
while adding my own thoughts after each.

  • This crisis
    was driven by fraud … on the part of mortgage loan originators,
    rating agencies, investment banks, and AIG.
    • Black
      attributes the collapse to fraud and equates this with a lack
      of regulation. However, as Sheldon Richman pointed
      out
      in connection with the Madoff scandal, this is a false
      equivalence. "Dear Ms. Maddow:
      Why do you call the government's failure to pursue fraud allegations
      in the Madoff case "deregulation"? Laws against fraud
      — that is, against the acquisition of someone else's property
      by deceitful means — have never been regarded as "regulation"
      or limits on free-market activity. They were simply part of
      the free market's common-law prohibition against violating person
      and property. Regulation, on the other hand, consists of government
      interference with private parties setting their own nonfraudulent
      terms of exchange in the market. By equating abstention from
      investigating fraud with laissez faire, you have allowed your
      ideology to blind you. Maybe this would be a good topic for
      discussion on your program." In other words, failure to
      investigate and prosecute fraud is a fundamental breakdown in
      the rule of law, much as it would be to do likewise for cases
      of murder or conventional robbery. It is not a characteristic
      of a free market. If we want to get to the bottom of the problems,
      as I believe Black sincerely does, we need to be very careful
      about diagnosing the problems correctly and a prerequisite for
      doing so is using accurate language. This is not mere quibbling
      about semantics.

    • It is
      worth noting that Black emphasizes the malfeasance of the above
      players, but completely ignores the roles played by the Fed's
      monetary policy, Fannie, Freddie, and the Community Reinvestment
      Act. I won't cover them here, as they are well documented by
      Thomas Woods in his book Meltdown,
      but will only point out here that they played a crucial role
      in precipitating this crisis. I am inclined to believe that
      this represents a blind spot in Black's perspective.

  • The FBI
    put out a public warning in September 2004 that there was an epidemic
    of mortgage fraud, which if it were to continue, would produce
    losses at least as large as the S&L debacle. However, there
    was a lack of regulation because after 9/11 the Justice Department
    transferred 500 white-collar specialists in the FBI to national
    terrorism and didn't replace them. Thus there are now 1/5th
    as many such agents working on these issues for a calamity which
    is at least 100 times as big as the S&L crisis.
    • This is
      clearly a problem but what does it tell us? It tells us that
      in government, resources will always be allocated on a political
      basis. After 9/11, it was politically expedient to divert resources
      being used for investigating bank fraud to fight terrorism instead.
    • Government
      will always be preparing to "fight the last war."
      After the Enron debacle, the Sarbanes Oxley Law was instituted
      at great expense, yet those rules did nothing to prevent the
      current breakdown. Maybe there is something more fundamentally
      wrong than simply an administration asleep at the wheel.

  • In
    1999, Congress got rid of the provision of the Glass Steagall
    Act (a post-1929 Crash law) which separated commercial and investment
    banking, a measure which enjoyed bipartisan support.
    • This certainly
      constitutes deregulation, but Black does not go on to demonstrate
      that this development did in fact contribute to the current
      breakdown. Sheldon Richman has indicated that it did not and
      I have yet to come across someone who could show that it did.

  • Chairperson
    of the CFTC (Commodity Futures Trading Commission) Bern attempted
    to acquire authority for the CFTC to regulate Credit Default Swaps
    (CDS, the instrument which was the undoing of AIG) but was blocked
    from doing so by Congress, others.
    • This is
      as close to a deregulation smoking gun as Black gets. I would
      concede that some of the problems with CDS might have been mitigated
      to some degree if the CFTC were given the requested authority.
      Whether this would have materially impacted the course of events,
      I am not so sure.
    • That said,
      the whole incident calls into question the whole premise of
      the regulatory model. If the regulated industry can control
      the course of the development of the rules, as was clearly the
      case here, how can we ever come to rely upon the regulators
      to act in "the public interest"? This is the whole
      topic of regulatory
      capture
      , or in more colloquial terms, the fox guarding the
      hen house. And regulatory capture is really a subset of the
      larger problem we face today, which is government capture.

  • The government
    did not enforce the Prompt Corrective Action Law, a measure passed
    after the S&L crisis which mandated closing failed banks.
    During Japan's financial crisis, our government repeatedly told
    Japan to use these processes, but Japan did not and had a "lost
    decade."
    • More government
      failure. Even when government appears to learn from earlier
      crises, whether or not those tools will be employed is at the
      discretion of subsequent administrations. And political considerations
      will decide this.

  • There needs
    to be a Congressional investigation to get to the bottom of what
    happened. Executives from the failed banks need to be replaced
    and successful regulators need to be appointed, not the same people
    who got us into this mess.
    • Sure,
      this is what ought to happen, but it won't unless an angry mob
      descends upon Washington demanding that they do these things.
    • More likely,
      to placate us we would get a "Blue Ribbon Panel" appointed
      by our rulers who will tell us what they want us to hear and
      will give a slap on the wrist to some of the "bad apples"
      responsible for this mess while discounting if not entirely
      ignoring many of the most serious criminals. When all is said
      and done, they will recommend sweeping new governmental powers
      to “ensure that a catastrophic financial breakdown will not
      recur.”

  • These problems
    were a result of ideologies which swept away regulation. Regulation
    and law enforcement mean that cheaters don't prosper and allow
    capitalism to function properly and honest purveyors to succeed.
    • As discussed
      earlier, free markets DO punish fraud, so if there was an ideology
      that was responsible for the non-punishment of fraud, it is
      not a free market one.
    • Free markets
      also punish reckless behavior by allowing companies and individuals
      to endure the consequences of their actions, not get bailed
      out. This is another way that they allow honest and prudent
      people to succeed.
    • Free markets
      also allow for open competition which over time will produce
      better businesses. On the other hand, for example, giving
      regulatory preferences to certain rating agencies
      will create
      a cartel instead, making it more likely for the poor performance
      of said companies noted after the crash of the Technology Bubble
      to continue.

  • There is
    a Dutch saying that it is not necessary to hope in order to persevere.
    • This much
      I think we can agree on. If more Americans felt this way, we
      would have President Paul right now, rather than President Obama.
    • While
      I have criticized some of Black's conclusions, I admire his
      honesty, courage and dedication.
    • I would
      love to include Black on a Blue Ribbon Panel to investigate
      the causes of the crisis and to make policy recommendations,
      along with others like Ron Paul, Tom Woods, Sheldon Richman,
      etc. Uh oh, I guess I have fallen back into "Hope"
      mode.

April
9, 2009

D.
Saul Weiner [send him mail]
is currently preparing for the commemoration of the liberation of
his ancestors from slavery. Unlike some other members of his religion,
he will not be devoting the remainder of the year to re-enslaving
his fellow man.

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