Friday, October 31, 2008


This Wall Street Journal article by James Freeman analyzes the "deregulation" that did NOT occur under the presidency of George W. Bush.


Anonymous said...

Richard, you are too smart to fall for this. That is unless you are trying to intentionally tow the Republican party line. There were several reasons for the financial crises, including deregulation.

I read the article you posted and I'm not sure how it applies to the financial crisis we are currently facing. The article goes to great lengths to suggest that Bush was increasing regulation (primarily accounting) over publicly traded equities. Assuming that is true, the only plausible conclusion is that Bush was misallocating resources and focusing his regulation on the wrong things while deregulating others.

In 2004, under the direction of Bush appointee Christopher Cox (SEC Chairman), the SEC allowed five Investment Banks — the three that have collapsed (Bear Sterns, Lehman Brothers, Wachovia) plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets (from a ratio of 12 to 1 to nearly 30 to 1) and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults. It only took 4 years for this plan to fail and literally take down the entire financial system with it. Upon its first "stress test" the model failed miserably with the collapse of Bear Sterns as there were no protection facilities for a "run on the bank scenario."

On September 23rd 2008, the Senate Banking Committee held a hearing on the Bush administration’s proposed $700 billion bailout plan. During the hearing, Christopher Cox testified that deregulation was a cause of the current financial crisis, including a “regulatory hole” in the credit default swap market [CDS]:

"There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion national market in credit default swaps — double the amount outstanding in 2006 — is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market.

Trading in the CDS market was what sunk insurance giant AIG. AIG had “sold large quantities of CDSs to financial institutions around the world,” and it came time to pay out on them AIG required an $85 billion federal bailout to keep its failure from affecting the wider financial system.

But its not just on credit default swaps that Cox has come around. He also blamed the Gramm-Leach-Bliley Act - which was constructed by former Sen. Phil Gramm (R-TX) in 1999 and deregulated the banking industry - for contributing to the financial meltdown. He said that “the failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake.”

RKirk said...

The focus of the article I linked was on the increased regulation that occurred during the supposed era of deregulation--foremost among which was Sarbanes-Oxley. You are correct, in my opinion, that there are "several reasons for the (current)financial crisis."

Among the major culprits of that crisis that you omit (many point to this factor as the major culprit) were the toxic loans, subsequently securitized, which were introduced into the financial system--primarily by Fannie Mae and Freddie Mac. These bad loans were encouraged by government regulators of the lending/banking industry, even demanded beginning in 1998, in order to extend home ownership to lower income individuals and to address supposedly discriminatory lending practices. Those bad loans were backed by the federal government via its implicit backing of Fannie and Freddie.

The Bush Administration sought legislation to restrain these GSEs--whose leverage ratios were also enormous ("investment banks on steriods" was, I think, the phrase used by one Princeton economist in his discussion of the financial crisis). They were frustrated by Democrats like Barney Frank and Chris Dodd who poo-pooed the idea that Fannie and Freddie were at risk. Some lauded the work of Franklin Raines (cf. Maxine Waters on the YouTube video extolling the great work of this allegedly criminal CEO). It is true, however, that the Bush Administration was very "proud" of the growing percentage of homeowners and probably did not push as hard as it should have against Democrat resistance to Fannie/Freddie regulatory reform in Congress.

It is correct to point out that increased leverage ratios were part of the financial crisis, given the government-encouraged bad mortgage debt--as were the rating agencies that certified mortgage-backed securities as high-grade when they should have been graded closer to junk.

Economist Stan Leibowitz (of the Bush-critical Independent Institute) has provided more detailed analyses of the Fannie-Freddie situation and its relation to the financial crises. I have a prior post that links to his material, which can also be found at the Independent Institute's website.

I reproduce below what I take to be the most critical components of the WSJ article presently under discussion:

"While government reduced the profit-making potential in Wall Street's traditional bread-and-butter business, it was simultaneously encouraging investment in the housing sector. Neither activity constituted deregulation...."

"Wayne Crews of the Competitive Enterprise Institute tracks regulation across the entire federal government. He reports that the Bush administration set an all-time record in 2004, when it published more than 75,000 pages of proposed and enacted rules in the Federal Register."

This increased regulation during the Bush years doesn't mitigate the point you make about Chris Cox and leverage ratios, but it does help explain why that regulatory blunder wasn't the sole cause of the financial meltdown.

RKirk said...

Here is a relevant Investor's Business Daily story about the effects of anti-redlining pressure on banks:

The Bank Terrorist
By INVESTOR'S BUSINESS DAILY Posted Wednesday, November 19, 2008

Housing: For years, a self-described "bank terrorist" blackmailed banks into making bad home loans in our inner cities. Now those loans are defaulting by the millions, and he's blaming banks....