Did deregulation cause the economic crisis?

[Meadmaker]

I've been looking around trying to find explanations for the current mess.

The left tends to blame deregulation. Can anyone cite examples of existing regulations that were repealed, modified, or not enforced by the Bush administration?

I found one of them. There had been a requirement for investment banks to maintain reserves against loss at 15:1. That was repealed, and the investment banks that were hit hard were much more highly leveraged than that. That seems like a horrible idea, but not enough to cause a crisis.

We know that, for some reason, some time around 2003-2005, mortgage brokers stopped asking for down payments, started issuing more ARM loans, created interest only loans, and in other ways took the brakes off people borrowing money for homes. Meanwhile, issuers of mortgage backed securities started packaging loans that previously they wouldn't have touched.

Why did they start then, and why hadn't they done it before? Were regulations repealed or modified that suddenly allowed these practices, whereas before they had been illegal? Are there specific cases we can point to and say that modification of this regulation or that regulation changed the market's behavior?

 

[liverleef]

Very good subject for a thread. I've wondered about this quite a bit myself. I've seen Democrats such as Pelosi claiming that Bush is responsible for this but they haven't been clear on the specifics. They just seem to be more interested in the finger pointing.

 

[Outback Jack]

I found this article on another forum and thought it was great. Its kind of long and detailed, but the details are what makes is so useful.

(I cant post links yet. Substitute characters for words)

http:[slash-slash]myslu.stlawu.edu/~shorwitz/open_letter[dot]htm


Cheers

 

[Wudang]

http://myslu.stlawu.edu/~shorwitz/open_letter.htm

 

[MIKILLINI]

I would say yes. Today, recession is only a small part of the threat that we face. Financial deregulation, Alan Greenspan’s low interest rates, and the belief that the market was the best regulator of risks, have created a highly leveraged pyramid of risk without adequate capital or collateral to back the risk. Consequently, a wide variety of financial institutions are threatened with insolvency, threatening a collapse comparable to the bank failures that shrank the supply of money and credit and produced the Great Depression.

Washington has been slow to recognize the current problem. A millstone around the neck of every financial institution is the mark-to-market rule, an ill-advised “reform” from a previous crisis that was blamed on fraudulent accounting that over-valued assets on the books. As a result, today institutions have to value their assets at current market value.

In the current crisis the rule has turned out to be a curse. Asset backed securities, such as collateralized mortgage obligations, faced their first market pricing in panicked circumstances. The owner of a bond backed by 1,000 mortgages doesn’t know how many of the mortgages are good and how many are bad. The uncertainty erodes the value of the bond.

If significant amounts of such untested securities are on the balance sheet, insolvency rears its ugly head. The bonds get dumped in order to realize some part of their value. Merrill Lynch sold its asset backed securities for twenty cents on the dollar, although it is
unlikely that 80 percent of the instruments were worthless.

The mark to market rule, together with the suspect values of the asset backed securities and collateral debt obligations and swaps, allowed short sellers to make fortunes by driving down the share prices of the investment banks, thus worsening the crisis. With their capitalization shrinking, the investment banks could no longer borrow. The authorities took their time in halting short-selling, and short-selling is set to resume soon, if not already.

If the mark to market rule had been suspendad and short-selling prohibited, the crisis would have been mitigated. Instead, the crisis intensified, provoking the US Treasury to propose to take responsibility for $810 billion more in troubled financial instruments in addition to the Fannie Mae, Freddie Mac, and AIG bailouts. Treasury guarantees are also apparently being extended to money market funds.

All of this makes sense at a certain level. But what if the $810 billion doesn’t stem the tide and another $800 billion is needed? At what point does the Treasury’s assumption of liabilities erode its own credit standing?

This crisis comes at the worst possible time. Gratuitous wars and military spending in pursuit of US world hegemony have inflated the federal budget deficit, which recession is further enlarging. Massive trade deficits, magnified by the offshoring of goods and services, cannot be eliminated by US export capability.
http://www.counterpunch.org/roberts09242008.html
ETA: Most of this could have been avoided if the Glass-Steagall Act wasn't repealed in 1999.
The Glass-Steagall Act, passed in 1933, mandated the separation of commercial and investment banking in order to protect depositors from the hazards of risky investment and speculation.

 

[trvlr2]

There was another bit of de-regulation which, I believe , accelerated and worsened the problems mentioned in earlier posts.
That was a meeting of the SEC in 2004, which lowered the margin requirements from the market.
Guess who was head of the SEC?
This was not reported widely. Almost no-one seems to know about it.
http://www.garp.com/blogs.aspx?blogmonth=6&blogyear=2008&blogid=332
Above is a good explanation of what happened. Below are the regulatory links.
http://www.nyse.com/pdfs/2004-39fil.pdf

http://www.sec.gov/rules/sro/nyse/34-52738.pdf

http://www.freetrade.com/forms/FRE086.pdf

http://edocket.access.gpo.gov/2005/05-22454.htm

 

[Meadmaker]

Mikillini,

One of the factors you noted was financial deregulation.

Do you know of any actual regulations that were eliminated, modified, or ignored?

If there was "de" regulation, then some regulations that had been in force must no longer be in force. Which ones were those? Does anyone know of any?

 

[Meadmaker]

There was another bit of de-regulation which, I believe , accelerated and worsened the problems mentioned in earlier posts.
That was a meeting of the SEC in 2004, which lowered the margin requirements from the market.
Guess who was head of the SEC?
This was not reported widely. Almost no-one seems to know about it.
http://www.garp.com/blogs.aspx?blogmonth=6&blogyear=2008&blogid=332
Above is a good explanation of what happened. Below are the regulatory links.
http://www.nyse.com/pdfs/2004-39fil.pdf

http://www.sec.gov/rules/sro/nyse/34-52738.pdf

http://www.freetrade.com/forms/FRE086.pdf

http://edocket.access.gpo.gov/2005/05-22454.htm

Thanks. You were posting this while I was posting to Mikillini. I haven't had a chance to read these yet, but it appears to be the sort of thing I was looking for.

 

[Gagglegnash]

Hi

Deregulation, in the past, has prompted a mad dash for profits before market pressures set in and self-correct the situation.

In this case, it was one of the causes.

So were the Federally mandated redefinition of, "income," to include stuff like child support and alimony payments, so that more low-income Americans could achieve the American Dream, and Federally mandated loan anti-discriminatory practices that sent bankers beating the neighborhoods for people to dress up their lending racial mixture reports so they could make more income from more loans to everybody.

Now, I can't demonstrate it (yet), but which party is ALL about poor people achieving the American Dream and ABSOLUTE racial equality in lending, regardless of income that doesn't disappear once the Ex has trouble gassing up his bass boat?

Poor people (like ME, for instance) should not be granted loans to buy houses, but as long as the bubble continued, the fantasy that people who could just barely get into a house with an adjustable-rate loan and zero-down, then refinance it to a fixed rate loan using the appreciation of the home as leverage for the new loan, this sort of thing was inevitable.

Bubbles always pop.

They can not keep going.

It's like the two hatters washed up on a deserted island each with a hat. They keep selling the same two hats back and forth for larger and larger profits until, when they're rescued, they're both self-made billionaires!

There just aren't that many resources, and 'POP' goes the bubble.

As soon as the housing market prices started back down, we were boned.

The zero-down guys had nothing invested, so there was no penalty for just walking away, right?

The people with irregular income flows hit the wall once the fuel prices went up, and couldn't refinance the home because the new price was less than what they owed.

Banks can't make loans with houses without losing money, and the money they lose comes straight out of their liquidity, making it even harder to loan money.

The government, both parties: The Republicans for turning off the smoke detectors, the Democrats for making sure everyone had plenty of flamable 'jammies and matches, mandated how the dominoes had to be set up. The bankers lined up the dominoes as fast and thick as they were allowed, and a bump in gas prices made Bubba put fuel in the bass boat instead of paying his alimony and child support, knocking over the first domino.

Well - that's how I see it, anyhow.

I'm still working to find out the specifics about the legislation involved, but, what with being poor white trash, homeless, and kind of sick recently, it's been going a bit slowly.

Please let me apologize in advance if I'm wrong about the origins of the flammy-jammie legislation.

 

[IllegalArgument]

I think it was a combination of deregulation and over-reliance on financial models that don't work.

About the models, see this thread.
http://www.internationalskeptics.com/forums/showthread.php?t=124569

 

[Meadmaker]

I think it was a combination of deregulation and over-reliance on financial models that don't work.

If it was deregulation, then somebody ought to be able to point to regulations that were repealed, modified, or ignored.

Margin requirements are one example, and they certainly made the situation worse.

Clearly, there was the wrong amount or type of regulation, but there has been a mantra from Democrats that deregulation caused it. After a couple of hours of googling, I could find very few examples of actual deregulation. Is it because I don't know where to look, or is the whole blame on deregulation a red herring? It seems obvious that it was an example of non-regulation of things that should have been regulated, but I've begun to question whether deregulation is actually a cause here.

I want to offer another possible hypothesis. I use the word hypothesis advisedly. I do not believe it to be true, but I think it is worth considering and looking for evidence.

One thing that everyone (with a clue at least) agrees on is that the real estate bubble was the heart of the crisis. Almost everyone agrees that the bubble was caused when people borrowed more than they could afford. They were willing to pay high prices because they could borrow more, and it had a feedback effect that they thought they were making money on their "investment" on their house.

The question, though, is what changed to allow this lending that had never happened before. Before, people checked closely and wouldn't lend to bad risks. Why now? I want to suggest that the single biggest contributor was actually technology. In the old days, to get a mortgage approved, you had to go to a real human being, who would examine real documents, and make a real decision, and be held responsible if they made lots of bad approvals. Suddenly, the process changed. People took some information, put it into a computer, and gave an instant approval. Consumers liked this, and any lending institution that put more brakes on the process would likely see their business go elsewhere. Lending company A gives me an answer in 20 minutes and a check really fast. If the bank actually slowed things down and said no more often, they weren't likely to get the business. They lowered their standards in order to compete with big mortgage brokers who were cranking out loans as fast as they could make them.

To emphasize, the above is a hypothesis. I'm looking for an explanation why so many people would write so many obviously bad loans. In the absence of examples of real deregulation, I came up with an alternative that would explain most of what I had seen.

 

[Francesca R]

Financial deregulation, Alan Greenspan’s low interest rates, and the belief that the market was the best regulator of risks, have created a highly leveraged pyramid of risk without adequate capital or collateral to back the risk.

I am curious why you say the highlighted part, rather than something more relevant like: "low inflation everywhere in the developed world and falling expectations of risk across almost all asset classes". The Fed chairman did not create those, and everyone including the public "expolited" them.

Washington has been slow to recognize the current problem. A millstone around the neck of every financial institution is the mark-to-market rule, an ill-advised “reform” from a previous crisis that was blamed on fraudulent accounting that over-valued assets on the books. As a result, today institutions have to value their assets at current market value.

You are correct to imply that this was a new regulation, not de-regulation. Yet you don't like it. (And I have some sympathy with why, actually) but this erodes the "deregulation caused it" charge.

The authorities took their time in halting short-selling, and short-selling is set to resume soon, if not already.

IMO banning short selling temporarily has pragmatic merit, but again this is *new* regulation not de-regulation, you are simply complaining it was too late. Note that (and I made a parody thread out of an economist article on this) to prevent the crisis being "caused" it would have been more meritable to have banned long positions than shorts. Excessive leverage (as you said) was an ingredient. That means borrowing to fund massive *long* exposure.

At what point does the Treasury’s assumption of liabilities erode its own credit standing?

That is a reasonable question, but pragmatically it is "not important now". If you were to judge by the performance of T-bills and government bonds, the US is *more* creditworthy now that they have committed this money. In fact that is not true because it actually reflects the belief that the creditworthiness of sovereign bonds (not just the US) has shot upwards relative to almost everything else.

ETA: Most of this could have been avoided if the Glass-Steagall Act wasn't repealed in 1999.
The Glass-Steagall Act, passed in 1933, mandated the separation of commercial and investment banking in order to protect depositors from the hazards of risky investment and speculation.

This is a view I have heard somewhat often (though only on this forum ), and I think it is wrong. That act did not stop regulated banks from "speculating" or taking on leverage, they just had the positive benefit of greater policy backing via deposit insurance coming from the state (and in fact that has become inadequate now and has had to be hugely strengthened in a number of countries already, with more likely to follow. An unchecked bank run on deposits would drive a traditional bank into the dirt just as fast as higher money-market funding rates did for Lehman Brothers. And the failure of an investment bank appears to have caused extreme panic in this case even though it had no depositors to run away from it. So reinstating the Glass-Steagall act would likely have achieved nothing at all.

Instead, what *has* happened is that former investment banks have now come under the regulations for traditional banks, voluntarily in the current environment. So that's more regulation again.

 

[trvlr2]

I am curious why you say the highlighted part, rather than something more relevant like: "low inflation everywhere in the developed world and falling expectations of risk across almost all asset classes". The Fed chairman did not create those, and everyone including the public "expolited" them.

You are correct to imply that this was a new regulation, not de-regulation. Yet you don't like it. (And I have some sympathy with why, actually) but this erodes the "deregulation caused it" charge.

IMO banning short selling temporarily has pragmatic merit, but again this is *new* regulation not de-regulation, you are simply complaining it was too late. Note that (and I made a parody thread out of an economist article on this) to prevent the crisis being "caused" it would have been more meritable to have banned long positions than shorts. Excessive leverage (as you said) was an ingredient. That means borrowing to fund massive *long* exposure.

That is a reasonable question, but pragmatically it is "not important now". If you were to judge by the performance of T-bills and government bonds, the US is *more* creditworthy now that they have committed this money. In fact that is not true because it actually reflects the belief that the creditworthiness of sovereign bonds (not just the US) has shot upwards relative to almost everything else.

This is a view I have heard somewhat often (though only on this forum ), and I think it is wrong. That act did not stop regulated banks from "speculating" or taking on leverage, they just had the positive benefit of greater policy backing via deposit insurance coming from the state (and in fact that has become inadequate now and has had to be hugely strengthened in a number of countries already, with more likely to follow. An unchecked bank run on deposits would drive a traditional bank into the dirt just as fast as higher money-market funding rates did for Lehman Brothers. And the failure of an investment bank appears to have caused extreme panic in this case even though it had no depositors to run away from it. So reinstating the Glass-Steagall act would likely have achieved nothing at all.

Instead, what *has* happened is that former investment banks have now come under the regulations for traditional banks, voluntarily in the current environment. So that's more regulation again.

Voluntary compliance? /= "more regulation", IMO.

Meadmaker:
Here's a clip from Harold Meyerson, Washington Post.


" Chief among those to whom responsibility attaches for the financial crisis that is plunging the nation into recession is former Texas senator Phil Gramm, McCain's own economic guru.
Gramm was always Wall Street's man in the Senate. As chairman of the Senate Banking Committee during the Clinton administration, he consistently underfunded the Securities and Exchange Commission and kept it from stopping accounting firms from auditing corporations with which they had conflicts of interest.
Gramm's piece de resistance came on Dec. 15, 2000, when he slipped into an omnibus spending bill a provision called the Commodity Futures Modernization Act (CFMA), which prohibited any governmental regulation of credit default swaps, those insurance policies covering losses on securities in the event they went belly up.
As the housing bubble ballooned, the face value of those swaps rose to a tidy $62 trillion. And as the housing bubble burst, those swaps became a massive pile of worthless paper, because no government agency had required the banks to set aside money to back them up. "

Take it one small bite at a time, you can handily eat an elephant. Looks like the bite was too big.
The last four years have seen some interesting regulatory changes.:
Take this with the margin rules changes I quoted before, mix well with "voluntary" compliance, throw in peak oil, et voila!

I can't say if this was done out of greed, or unintended consequences, or both. Still trying to figure it out.

 

[Francesca R]

Voluntary compliance? /= "more regulation", IMO.

Probably semantic, but it may have happened via compulsion anyway. It was voluntary because there is a benefit to it beyond the "benefit" of doing what you're compelled to do, and that benefit is valued a lot more highly today.

 

[andyandy]

I would agree completely that deregulation is the primary reason why the bust in the boom and bust cycle is so severe. The idea that markets can be left to self regulate is absurd. The whole system is motivated by a desire to make as much money as possible. Shareholders chase big capital gains or fat dividend payments, and directors are suitably incentivised to provide them. There is no social altruism, and a significant skew towards short-term performance. This is fine, capitalism is selfish. But because it is, it needs regulating externally to prevent excess.

When the dust settles, significant blame will also have to be apportioned to the sub prime mortgage lenders, the ratings agencies which delivered AAA for what is now trading as junk, and the mathematical models which predicted that risk could be dispersed throughout the financial system (where instead we have contagion throughout the system).

But first and foremost the laissez-faire attitude of the British and American governments towards regulation of the financial sector has to be blamed. Rather than asking questions as to what regulations had been relaxed, I think it's more pertinent to look at how the regulations failed to keep up with the changing finance methods over the last few years. Much greater leveraging, much more collateralised debt, much more off the balance sheet trades, much more exposure to commodities. I can't remember any of the figures offhand, but around the year 2000 all of these massively increase. And as a result the business models outgrew the regulation framework in place.

 

[Meadmaker]

But first and foremost the laissez-faire attitude of the British and American governments towards regulation of the financial sector has to be blamed. Rather than asking questions as to what regulations had been relaxed, I think it's more pertinent to look at how the regulations failed to keep up with the changing finance methods over the last few years. Much greater leveraging, much more collateralised debt, much more off the balance sheet trades, much more exposure to commodities. I can't remember any of the figures offhand, but around the year 2000 all of these massively increase. And as a result the business models outgrew the regulation framework in place.

But if we are saying that the cause is "deregulation", then there must be a "de" portion. There must be something that had been regulated, and now wasn't.

I think the second part is correct, that regulation failed to keep up with changing methods. Obviously, something went wrong. We are in one heck of a mess, and government is supposed to work to prevent it.

However, that isn't "de" regulation, is it?

What I am wondering about is why those financing methods changed. Why did the banks stampede like lemmings over a cliff? I had bought into deregulation as the cause. I had suspected that government regulations had prohibited the destructive lending of the last few years, and Bush et. al. repealed those regulations, but when I went to find examples where the Bush administration cancelled regulations, the "de" in deregulation, I could find very few of consequence. I began to speculate that there must be some other cause.

Don't get me wrong. I'm not going to let the Bush administration off the hook if I am going to start finger pointing. Whatever went wrong, they were in charge when it happened. However, finding someone to blame doesn't actually lead to comprehension of the problem.

 

[Francesca R]

The idea that markets can be left to self regulate is absurd.

That's a strawman as no country has, nor wants, completely unregulated markets.

The whole system is motivated by a desire to make as much money as possible.

The whole what system? That's what motivates paper-clip manufacturers too. Are you going to try to argue that investment bankers have a monopoly on self-interest, greed and (now) fear?

There is no social altruism, and a significant skew towards short-term performance.

What is actually providing this "skew to short term performance"? Do you think that society needs to legislate to compel a longer time horizon on earnings per share? By the way this is a sincere question. Because if a deregulated incentive structure is what leads to the wrong (too short) time horizon--then it is, in fact, human nature that is at work in this race-to-the-short-term isn't it? So it would seem that this argument would lead to regulations to protect people from themselves.

This is fine, capitalism is selfish. But because it is, it needs regulating externally to prevent excess.

Yes. Specifically this is because excessive leverage that goes wrong throws off big negative external costs, not unlike pollution.

When the dust settles, significant blame will also have to be apportioned to the sub prime mortgage lenders, the ratings agencies which delivered AAA for what is now trading as junk, and the mathematical models which predicted that risk could be dispersed throughout the financial system (where instead we have contagion throughout the system).

You omit the members of the public who ran down their own personal saving rate too low and leveraged up their own balance sheet too high and screwed up their own risk management too. Nobody compelled them to do this. They can't even claim competitive business pressure as an "excuse".

Related to your point, I think it is instructive that there is a general absence of lawsuits in any parts of the chain that you just outlined. Is it not extraordinary that nobody can actually claim that they were mis-sold to or defrauded and that nobody was guilty of negligence under any law? The thing is, lengthy prospectuses for CDO and other credit derivative structures were drawn up, and ratings of issues were comprehensively couched with caveats, just like home buyers were warned that their interest rate would re-set to a level that could be a lot higher and that their home was at risk if they could not keep up repayments on a mortgage or other loan secured on it. . . .

So the problem was that nobody listened to or read the stuff. Because that is what everyone else was doing.

But first and foremost the laissez-faire attitude of the British and American governments towards regulation of the financial sector has to be blamed.

Whhy are you singling those ones out? By now it should be obvious that other countries' systems must be at least as deficient. They (and some posters here not too long ago) simply had a greater propensity to engage in wilful denial for a bit longer than the Americans.

I think it's more pertinent to look at how the regulations failed to keep up with the changing finance methods over the last few years.

That is a legitimate question yes--though it shifts the emphasis off your opening sentence a bit. "Lack of the right kind of smart regulation", rather than "deregulation" would be the cause then, wouldn't it?

And as a result the business models outgrew the regulation framework in place.

Yes.

 

[Meadmaker]

I checked out the Commodities Futures Modernization Act. If I understand it correctly, it seems like an absolutely awful bill.

Passed by a Republican Congress, it was signed by Bill Clinton shortly after the issuance of Bush v. Gore, i.e. when he was a lame duck and it was finally clear that the next President would be George W. Bush.

I would like to know what President Clinton was thinking at the time. However, even that, if I read the description of the bill correctly, was not actually "de" regulation. It prevented future regulation, but didn't repeal any existing regulations on Credit Default Swaps.

 

[quixotecoyote]

The repeal of Glass-Steagall has been mentioned, but has anyone called the passage of the Responsible Lending Act?

http://losangeles.injuryboard.com/m...periment-in-deregulation.aspx?googleid=242468

eta: I'm trying to find more details but it looks like the CRA regulations may have been butchered in 2004

http://www.morganhilltimes.com/opinion/248916-deregulation-is-reason-for-subprime-mortage-crisis

Failure to regulate (not really de-reg per se) bond rating agencies, hedge funds, and private equity hurt too.

http://www.prospect.org/cs/articles...s_of_deregulation_and_three_necessary_reforms

 

[quixotecoyote]

I would like to know what President Clinton was thinking at the time. However, even that, if I read the description of the bill correctly, was not actually "de" regulation. It prevented future regulation, but didn't repeal any existing regulations on Credit Default Swaps.

I think actions to prevent regulation are the opposite of regulation and are therefore synomous with deregulation, but that's only relevant if you're concerned with the semantics of the issue.