DE-regulation Caused the Housing Bubble?


It would be convenient to point to specific events in history which caused the cards to tumble in 2008 but this would not be realistic.  The most honest way to determine the cause(s) of the crash(es) is to look at what actually happened.  In a nutshell, the effects of overpriced real estate rippled throughout the economy.  A real estate bubble of this size would be impossible without the support of intense regulation and subsidy.

However, according to Mr. Weissman (12 Deregulatory Steps to Financial Meltdown), the crash was the result of twelve specific instances of deregulation.  Let’s examine his “proof”.

1. The repeal of Glass-Steagall
Mr. Weissman suggests that with the repeal of Glass-Steagall banks were now able to invest more cash (from checking and savings accounts) into risky new instruments such as the infamous MBS or credit default swap.  However, he conveniently leaves out the reason why banks are able to invest their customers’ money willy-nilly into such risky ventures: this money is largely guaranteed by the FDIC.  The bank could lose every dollar on deposit without affecting most of its customers’ savings.  Talk about free money!
2. Off-the-books accounting for banks
This is a favorite tactic of the government as well but is not the result of deregulation as his post implies.  That said, dishonest practices such as this are the result of government regulation, not deregulation.
3. CFTC blocked from regulating derivatives
Another example of a practice which was not deregulated.  However, the claim that regulating a financial instrument creates safety for consumers is patently fraudulent as evident by the extensive history of bubbles and crashes within regulated instruments.
4. Formal financial derivative deregulation: the Commodities Futures Modernization Act
A restatement of “proof” number three which we already discussed.  So much for “12 deregulatory steps to financial meltdown”.
5. SEC removes capital limits on investment banks and the voluntary regulation regime
Yet another so-called “deregulation” that isn’t.  Mr. Weissman claims that the removal of the capital limits allowed banks to push debt to net capital ratios “to as high as 40 to 1” resulting in “a more tangled mess of derivative investments”.  Banks previously were allowed debt ratios of 15 to 1 which he appears to consider acceptable risks.  However, the only way to determine adequate risk levels is through the pricing system.  If a bank is all but guaranteed a bailout in the event of excessive risk, the problem is not with the debt ratio, which is arbitrarily chosen, but with the insulation of risk itself!  A bank which must consider the possibility of the redemption of its debt is more apt to make wise decisions regarding its scarce capital.  As the definition and redemption of capital becomes blurry due to the de facto guarantee by the Fed, banks get more loose with their practices because they don’t have to worry about the effects of failure.
6. Basel II weakening of capital reserve requirements for banks
Mr. Weissman admits that this particular “proof” has not even been implemented yet (if ever).  It makes one wonder who his intended audience is and whether or not he believes they will even bother to read his piece.
7. No predatory lending enforcement
He now expects us to believe that a lack of predatory lending enforcement (again not an instance of deregulation) resulted in a real estate crash.  Perhaps he should have focused more on the ability of prospective homeowners to obtain financing with little to no proof of income, no proof of employment, poor credit history, and all of the other glaring warnings which banks ignored in an effort to put people into homes.  The result of which was created by government programs to lower credit requirements and guarantee loans once they were approved.  Where’s the deregulation?
8. Federal preemption of state enforcement against predatory lending
I will agree with his implied frustration with obtrusive federal meddling but once again this is not an instance of deregulation.
9. Blocking the courthouse doors: Assignee Liability Escape
Finally, Mr. Weissman brings up a good point.  Why should the liability of MBS holders be different than that of any other investment instrument?  However, this is yet another example the unintended consequences of government regulation at work.  This exemption would not be possible without some sort of legislation making it so.
10. Fannie and Freddie enter subprime
Fannie, Freddie, Ginnie and all of the other kids are all major players in the real estate crash yet Mr. Weissman shrugs them off as “not responsible for the financial crisis”.  Then why bother including them in your list?!  Half of the items on his list would not even be possible were it not for these GSE giants!  These agencies allowed the reckless mortgage issuance to begin and blossom by securitizing the risky mortgages and providing a secondary market of virtually risk-free securities.  I will agree that these GSEs are not the cause of the crash but they are certainly major factors.  And as usual, this is not an example of deregulation.
11. Merger mania
He almost gets this one right.  Mr. Weissman claims the “deregulatory maneuvers enabled [the banks] to combine size, explicit and implicit federal guarantees, and reckless high-risk investments”.  In other words, repealing the Glass-Steagall act (his only example of actual deregulation), combined with federal guarantees (which are only possible thanks to industry regulation), on top of risky investment instruments (which again are only possible due to government regulation) somehow caused the crash.  Deregulation indeed!
12. Credit rating agency failure
Topping off his list of “12 deregulatory steps to financial meltdown” is the final non-deregulation step.  The credit rating agencies enjoy a government provided oligopoly of their industry.  Various regulations encourage the overvaluation of government debt and has almost single-handedly allowed the entire government (at all levels) to issue debt beyond a reasonable or fiscally sound level.  Governments are essentially broke and deserve an ‘F’ rating, not the ‘AAA’ that they have been handed for years.
In summary, Mr. Weissman provides us with only one example of deregulation and expects us to glaze over his redundancies and finger-pointing to draw the conclusion that only government regulation can cure this problem which “Wall Street has wrought”.  Instead, I encourage readers to consider the other parties of this issue: namely the government.  Without implicit and explicit government guarantees, regulation, and coercion, the real estate market would not have become overvalued as it did thus preventing the creation of an explosive real estate investment bubble which ultimately burst.  Over-regulation cannot be cured by more regulation.

Leave a comment

Your email address will not be published. Required fields are marked *