Peter Wallison and Steve Randy Waldman have each written a thought-provoking and important analysis of the effect of regulation on the recent financial crisis.
First Wallison:
What caused the financial crisis?
The widely accepted narrative, prominent in the media and pressed by the Obama administration, is that the crisis was caused by deregulation–the "repeal" of the Glass-Steagall Act and the failure to regulate both derivatives and mortgage brokers–which allowed excessive financial innovation, risk taking, and greed among financial players from mortgage brokers to Wall Street bankers.
With this diagnosis, the proposed remedy is more regulation and government control of the financial system, from the over-the-counter derivative markets to mortgage brokers and the compensation of CEOs.
The alternative explanation is that the crisis was caused by the government’s own housing policies, which fostered the creation of 25 million subprime and other low-quality mortgages–almost 50 percent of all mortgages in the United States–that are now defaulting at unprecedented rates.
In this narrative, the fact that two-thirds of all these weak mortgages are now held by government agencies, or were produced by government requirements, shows that the demand for these mortgages–and the financial crisis itself–originated in Washington.
The problem for the administration’s narrative is that its principal examples do not stand up to analysis: the repeal of a portion of the Glass-Steagall Act did not eliminate the restrictions on banks’ securities activities (they were left unchanged), the mortgage brokers were responding to demand created by the government, and, there is no evidence that the failure to regulate credit default swaps (CDS) had any effect in causing or enhancing the financial crisis.
Without a persuasive explanation for the cause of the financial crisis, the administration’s regulatory proposals rest on a mythic foundation.
And Waldman:
An enduring truth about financial regulation is this: Given the discretion to do so, financial regulators will always do the wrong thing.
Remember — it’s the incentives, folks.
Yeah, it is the incentives. On both sides. The incentives of the regulators concern me a bit, it ain’t like they don’t have any. Question is, what are they, really. Is it for the good of the country, the financial well-being thereof? Or what?
In examining regulatory failures in the financial services industry, we have utterly failed to examine the actions ao the regulators themselves. Instead, we have chosen to begin to craft additional regulations to be “enforced” by the same incompentent individuals who failed us in the past. This is simply appalling.
All too often, regulators are not accountable to anyone and they simply have neither an incentive to be activist nor a penalty for being negligent. Accordingly, the main goal of those in regulatory positions is to preserve their own personal interests in their bueaucratic structures. To have effective regulation in the financial services sector, we both need to change the culture of our regulatory agencies and also to replace senior regulatory agency management with those who both can enforce current regulations and want to enforce current regulations.
We don’t have a crisis in sectors such as aviation. That is instructive. Senior regulators at the FAA have an effective approach to crafting, implementing and enforcing regulations in that aviation sector. We need to have a discussion discussing why the culture of those regulatory agencies with successful track records cannot be applied to those agencies who have proven to be abysmal failures. Sadly, for purely political reasons, this will never happen.
It is also important to remember that regulation is not a one time thing. The regulators issue their regulations and then the regulated dream up alternatives that may eventually have to be regulated. Too many people seem to think regulation is a “one and done” kind of thing.
Then, too, we have the fact regulators are inevitably captured by the regulated.
Rick
It is also important to remember that regulation is not a one time thing. The regulators issue their regulations and then the regulated dream up alternatives that may eventually have to be regulated. Too many people seem to think regulation is a “one and done” kind of thing.
Then, too, we have the fact regulators are inevitably captured by the regulated.
Rick
Risk,
The rationale for the Self Regulated Organization structure in the financial services industry was that it would allow those with both the expertise an arguably complex industry and the vested interest in maintaining a fair and efficient marketplace to quickly craft rules and regulations necessary to address unexpected issues.
Sadly, those in positions of power realize that their individual interests are to create an inefficient marketplace and to ensure they have the ability to exploit the inefficientcies they created.
Herein lies the problem, those in positions of influence understand their individual fortunes can be expanded by fostering an inefficient marketplace and the interests of the country are best served by ever increasing efficientcy in the financial markets.
Given the power of legalized bribery we can “political campaign donations” and “employment promises after public service” guess who wins in the end…I’ll give you a hint – it isn’t the American people.
Just wait, I’ll bet you any amount of money that when Tim Geithner leaves the Treasury he goes to work for Goldman Sachs.