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  • Bad Regulation, Not Deregulation, Caused Financial Crisis

    Niall Ferguson

    Harvard University professor Niall Ferguson writes in the New York Times:

    Human beings are as good at devising ex post facto explanations for big disasters as they are bad at anticipating those disasters. It is indeed impressive how rapidly the economists who failed to predict this crisis — or predicted the wrong crisis (a dollar crash) — have been able to produce such a satisfying story about its origins. Yes, it was all the fault of deregulation.

    There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans — who supposedly have much better-regulated financial sectors than the United States — have even worse problems in their banking sector than we do. The German government likes to wag its finger disapprovingly at the “Anglo Saxon” financial model, but last year average bank leverage was four times higher in Germany than in the United States. Schadenfreude will be in order when the German banking crisis strikes.

    The reality is that crises are more often caused by bad regulation than by deregulation. For one thing, both the international rules governing bank-capital adequacy so elaborately codified in the Basel I and Basel II accords and the national rules administered by the Securities and Exchange Commission failed miserably. It was the Basel system of weighting assets by their supposed riskiness that essentially allowed the Enronization of banks’ balance sheets, so that (for example) the ratio of Citigroup’s tangible on- and off-balance-sheet assets to its common equity reached a staggering 56 to 1 last year.

    Posted in Economics [slideshow_deploy]

    10 Responses to Bad Regulation, Not Deregulation, Caused Financial Crisis

    1. Ozzy6900, CT says:

      So the article just proves that sticking your fingers into the Capitalism Machine just screws up the process! the Financial Markets work fine if left to their own rules and consequences.

    2. MAS1916 - Denver, CO says:

      Oh yes… deregulation is the problem. When it was brought to Barney Frank's attention that housing was headed for a crash unless lending was brought under control, Frank went to lunch. Frank was warned, but because the lending practices at the time favored those that couldn't normally afford to purchase a home, Frank did nothing.

      Chris Dodd did such an admirable job executing his congressional oversight job that AIG contributed thousands to his last campaign.

      Regulation itself is not the problem, being smart about regulating pieces of the economic engine is what is important.

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    6. Ross Writes, Bradent says:

      I once thought there were only three branches of the federal government, the executive, the legislative, and the judicial. It seems that I am wrong. There is a fourth, more powerful than the other three combinated, for it inteferes with daily life of every American, dead, alive or unborn; the REGULATORS. They are the bastard child of the executive and legislators with the judical being the Godfather.

    7. NEAL says:


    8. Bob Decker, CFA in C says:

      Any single explanation as a cause for the financial crisis is woefully inadequate and probably stated with some limited agenda. Perhaps the best explanation turns to that observer of human nature, Pogo: “We have met the enemy and he is us.” A list of causes which I developed with the help of fellow analysts would need to include:

      • A patchwork of regulatory agencies with competing agendas, which allowed financial firms and financial products to engage in “regulatory arbitrage” or escape regulation completely. One over-riding theme is not “deregulation” but a massive failure of overlapping, inconsistent, and conflicting regulations. Basel II international standards on bank capital need to be included. Those standards allow for banks to use their own “approved” risk models to calculate how much capital needs to be maintained for varying risks of different financial investments. (Whoops!)

      • Legislative (and some Executive) acquiescence in maintaining the patchwork to protect turf and pet priorities (e.g. Fannie Mae and Freddie Mac; Community Reinvestment Act; Congressional stonewalling attempted regulatory reform by claiming “no need to fix what isn’t broken.”)

      • Mortgage originators who underwrote mortgages without standards (e.g. those the market began calling “liar loans”) for investment bankers who could likewise transfer the risk (until the music stopped) because they had protected agency purchasers. The culprits also need to include private buyers of mortgage and other consumer debt, who, through numerous “right sizing” reorganizations, had reduced in-house research, opting instead for…

      • Over-reliance on credit rating agencies with a protected oligopoly and a strong financial incentive to assign the highest rating the bond issuer demanded.

      • Shareholders (also known as equity investors) who pressured chief executives to produce growth in financial services companies to match that of tech companies, all the while having no say about base-pay and incentive compensation packages approved by Boards of Directors who were supposedly independent, but who, in reality, were members of the same tight little country club set as the chief executives. (My mother, a retired high school English teacher, would be appalled at that elongated sentence.)

      • Undisciplined fiscal policy with massive tax cuts (usually good, except) with no spending cuts to match. The Republicans forgot part of Ronald Reagan’s formula: you cut Congress’ allowance in order to cut its spending; rather, as The Economist correctly pointed out, the Republican Congress “spent like drunken sailors.” Now, the tax and spend Democrats are back!

      • Monetary policy, which created moral hazard by consistently slashing interest rates to bail out over-leveraged trading desks and consumers and, therefore, started to feed the next bubble. Concern grew that the equity and bond markets came to expect that the “Greenspan Put” and a new “Bernanke Put” would bail them out.

      • Currency policies of emerging market governments in an effort to keep the local currency value relative to the dollar at a level which would maintain exports (which also benefited the over-leveraged U.S. consumer.)

      (See http://www.torpboat92k.wordpress.com)

    9. mike baker Dallas C says:

      Hey, that's what I was gonna say.

    10. Gyonfdtw says:

      vrdR4z comment1 ,

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