Progressive Regression II | Financial Regulation Crisis

– By: Larry Walker, Jr. –

Government Regulation vs. Self-Regulation

Once again, the Progressive Obama Administration’s magical solution, for all problems American, is more government regulation. But is government regulation really any better than self-regulation? Progressive government regulation is even worse. (A Progressive regulator is pictured to the left.)

I contend that banks and financial services companies have a direct interest in the safe, efficient, and profitable business of making loans, investments, and protecting assets. Would it benefit a bank to carelessly make loans to unqualified borrowers, taking the risk of never being repaid? No. Would it benefit a financial services company to recommend investments in financial instruments that continually lose money? No. Every private sector company has a direct interest in self-regulation.

Surely there will be incidents of fraud, theft, and abuse, but when such incidents occur, private companies will pay stiff fines under applicable Federal and State laws. When it is discovered that laws have been violated, corporate employees, and executives often face stiff fines and/or prison time. But what happens when government regulators screw up?

On August 9, 2007, former SEC Commissioner, Roel C. Campos officially announced his resignation.

On October 2, 2007, former SEC Commissioner, Annette L. Nazareth, a nine-year SEC veteran, officially announced her resignation.

On August 13, 2008, Florida’s top financial regulator, Don B. Saxon resigned before he could be fired. He was blamed for lax enforcement of state laws which allowed convicted felons to be licensed as mortgage brokers, including individuals who took part in mortgage fraud.

On January 26, 2009, Timothy Geithner, former President of the Federal Reserve Bank of New York, was sworn in as Secretary of the Treasury.

On May 7, 2009, Stephen Friedman, the former chairman of the Federal Reserve Bank of New York, abruptly resigned; days after questions arose about his ties to Goldman Sachs.

When regulators make costly mistakes most of them simply resign, disappearing into the shadows with taxpayer funded golden-parachutes. However, in some cases (Geithner) they get promoted. So there is no accountability when it comes to government regulation.

The case against more government regulation:

Raymond Richmond, in his latest article, Geithner and Summers Make Their Economic Mistakes Transparent, reminds us that the last major governmental intrusion into the private financial sector is what created our current recession. Instead of learning the valuable lesson that ‘government regulation equals no regulation’, the Progressive Obama Administration’s solution, like a junkie in relapse, is more of the same. “This time it will be different.”

“Here at home, we are on the verge of completing the most sweeping financial reform in more than 70 years.”

They failed to mention that the last major intervention in bank regulation caused this recession. Beginning in 1977 with the Community Reinvestment Act, every administration pressured the banks to make loans on easy terms, turning their eyes away from the housing bubble they were causing and the dangerous lack of collateral backing most mortgages. Government created two Government Sponsored Enterprises, Fannie Mae and Freddie Mac to create a secondary market for such ill-fated loans. Wall Street got into the act and created derivatives which brokers sold all over the world. When the housing bubble burst, the U.S. and Europe’s largest banks and insurance companies faced bankruptcy, and stock markets round the world collapsed. The U.S. does not need new bank regulations; it needs to keep the politicians from making decisions that should be left to the shareholders of private firms who have the major stake in the firm’s success. This is the lesson that should be learned around the world.

The past year and a half has seen unemployment grow in the U.S. to double digits, factories disappear, witnessed a worsening in the distribution of income, saw soaring government budget deficits, saw the U.S. dollar, the world’s standard, lose more than a third of its value in foreign exchange.

Prospects have never been worse. And all of these are the product of government intervention in the private economy. This is the lesson the G-20 ought to learn, government intervention in the economy usually does more harm than good. That would include intervention in the economy by the G-20, should it become an institution that makes and enforces decisions.

Michael Pomerleano in a Financial Times article entitled, The Failure of Financial Regulation, explains how government regulation failed. This is more proof that all of the time, effort, and money spent on government financial regulation has been for naught.

The regulation and supervision of the banking system rest on three pillars: disclosure to ensure market discipline, adequate capital and effective supervision.

Did the regulatory philosophy governing our financial markets withstand the test of the recent crisis? My conclusion is that all three regulatory pillars failed.

Was adequate information available before the crisis erupted? The information on the subprime exposure was out there for anyone who had the determination to collect and [analyze] the (sometimes patchy) data from quarterly 10Q reports filed with the Securities and Exchange Commission for US banks, supplemented by rating agencies’ and investment banks’ research reports.

A final question we need to ask is how effective was the supervisory apparatus in this crisis?

It is reasonable therefore to infer that the regulatory agencies would have taken notice of those estimates as early as the autumn of 2007. For a long time the regulatory and supervisory apparatus was silent.

We need to question why didn’t any regulator add up the potential size of the losses on the sub prime exposure, based on publicly available information, and verify them with on-site examinations?

Why wasn’t there a far more forceful response from the supervisory agencies? Equally, we should have expected credit rating agencies, investment research and investors to respond more forcefully. In this context, one can only express puzzlement and disappointment at the tepid regulatory reaction. Only after the monumental policy mistake of allowing Lehman Brothers to fail, did the authorities grasp the full significance of the problems and we witnessed a systematic effort to manage and contain the crisis.

Finally, Glenn Hubbard in his Harvard Business Review Article, Financial Regulation: It’s Not About More, reminds us that over-regulation by the government can do more harm than good.

…the economic concern that over-regulation of financial instruments and institutions in the name of safety can lead to aggregate harm — most obviously by raising the cost of funds to household and business borrowers. The key is to design regulation to insure proper pricing of risk and information about risk — such an approach (not that really taken in the bill winding its way through Congress) offers the right balance between protection of the individual and society.

The end result of the Progressive Obama Administration’s magical plan of more government regulation will lead directly to higher costs for American consumers and businesses. Businesses will pass their costs on to customers. Consumers will be hurt. Those who get hurt the most will be those on the lowest end of the economic food chain. Thus, the end result of Barack Obama’s cowardly, status quo, regressive, regulation policies will be to harm those that he claims to be helping.

Smaller government and less governmental regulation will lead to lower taxes, lower consumer prices, greater accountability, more freedom, and more opportunities for wealth creation. What exactly have we gotten in return for all of our money that has been squandered on regulating the financial industry? What will we get with Obama’s ‘more of the same’ approach?

4 thoughts on “Progressive Regression II | Financial Regulation Crisis

  1. Actually the financial crisis is the direct result of de-regulation – Please read about the glass-stegal act and it's repeal in 1999.

    The trades where the Taxpayer bailed out Wall Street were all the OTC trades which weren't regulated by the Government.

    So AIG had all the all the freedom to self-regulate, Goldman Sachs had all the freedom to self-regulate, Lehman had all the freedom to self-regulate, yet they didn't and when the chickens came home to roost they put a gun to the head of the credit market. If they didn't get their bailout, we would have seen credit cards with 100% APR, mortgages at 10% and business loans would be impossible to get.


  2. I contend that the reason was over-regulation, as explained. The Community Reinvestment Act of 1977 was the beginning, when banks were forced to make loans to unqualified borrowers, and the Government made a market for the bad loans.

    You have to get to the root of the problem. Treating a symptom like over-the-counter trading solves nothing. All the Progressives want to do is continue the same failed policies with more regulation.

    Well it didn't work then, and it won't work if you regulate everything to death. At that point, markets cease to function.


  3. Here's the problem, we had the CRA since 1977. The economic cycle went through several expansions and contractions since then. No major housing crash.

    We repealed glass-steagall in 1999, we reduced the regulatory burden on Financial companies. Then we have the first major correction, and it's Financial Armageddon. But it's the CRA's fault, It's regulation's fault.

    Also before the financial regulation, we didn't have Recessions, we had Panics.


  4. I'm not sure exactly what you're trying to say, but Glass-Steagall was a form of bank regulation, and so was the CRA. The CRA was pretty much dormant until it was expanded under Clinton in 1996; Glass-Steagall was repealed in 1999. When Glass-Steagall was passed, back in 1933, there was no sub-prime housing crisis, and there was no Fannie or Freddie, it was a totally different situation.

    See my post: “Obama Stumbles on Glass-Steagall”

    Just because we had a stock market correction in 2007-2009 doesn't mean that it was due to the same reason that it happened in 1929 or for that matter 2001-2002.

    It is interesting to note that even, the co-author, Senator Carter Glass himself moved to repeal the GSA shortly after it was passed, claiming it was an overreaction to the crisis.

    Also see my post: Real Financial Reform, Part I: The Option ARM and part II after that.

    There were no Option-ARM loans in 1929 either.

    1929 – Commercial Speculation
    2001 – Internet Bubble
    2007 – Housing Crisis

    I think all government regulation is an over-reaction when it involves regulating private enterprise. Government can't even regulate itself, but that what it should be doing. However, if you want to reform something, then reform the thing that needs reform, not something that may or may not have needed reform in 1929.

    I guess there just aren't any new ideas out there. Every time they have to dig up some 90 year old guy who was around in 1929.


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