Did deregulation cause the economic crisis?

[Meadmaker]

MeadMaker: Fannie Mae and Freddie Mac are Government Sponsored Enterprises,

Your argument is, at least in part, that any action by a GSE, or by the central bank (the fed) constitutes government interference in the free market, and you are equating that with regulation.

I don't think you are wrong. However, you are off on a page that just isn't in line with what either political party in the United States is thinking. We aren't going to shut down the Fed any time soon. We could shut Fannie and Freddie, but it isn't very likely.

When we talk about deregulation vs. strict regulation, we aren't really talking about government interference in markets. Maybe we should be, but we aren't. Technically, giving Freddie and Fannie free reign is a form of "regulation", because it constitutes government interference in the market for some government, frequently non-economic, motive, but that isn't what we mean when we talk about tighter regulation. When we say deregulation, we mean letting Fannie and Freddie, and maybe other financial institutions, have more rope.

FWIW, I think that Fannie and Freddie probably shouldn't exist, and I think that government should be extremely cautious in promoting such superficially great goals as low income home ownership. That way lies madness. However, we are there and neither President Bush, Congressional Democrats, nor Congressional Republicans want to go any other route. It's just an argument about the best way to get there.

It may be true that CRA loans themselves have a lower rate of default than the rest of the economy, but it is also true that the CRA, and the expansion of its role under Clinton, opened the door to these "creative" financing techniques.

Why would the door have been closed were it not for the CRA? I don't think the CRA had anything to do with opening the door to these creative financing techniques. Certainly the quote you posted doesn't indicate such.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

So, it was "under increasing pressure" from the Clinton administration? Unless I misread something, that means the Clinton administration didn't actually do anything, but threatened to do something in the future. Meanwhile, stockholders were demanding more profits. That seems like ordinary stockholder behavior.

However, this was posted in repsonse to my request for backing of your claim that "Congress explicitly directed Fannie and Freddie to expand their lending to borrowers with marginal credit". But this quote doesn't mention any explicit direction from anyone, and it doesn't mention Congress at all.

How can the stricter land use regulations be so unconvincing as a regulation causing the problem? These were "open space" laws, motivated not by attempts to deal with human problems caused by economic and population growth, but by environmentalist ideology.

The desire to live near green, undeveloped, land is not environmentalist ideology.

If you want to help poor people own their own homes, contribute to "Habitat for Humanity", or become an architect or developer with a mind towards creating affordable housing. Don't go pumping hundreds of billions of dollars into the housing industry. That will only inflate housing prices. Don't use government to encourage bankers to lend more money. Same thing.

While I have criticised your response about what constitutes "deregulation", I wish to say again that I agree with your core claim, as expressed here. I do think that it should not be a goal of government to help poor people own their own homes. Certainly, such a goal should not be accomplished through direct or indirect market manipulation, or anything that remotely resembles income transfer. Unfortunately, we have two political parties that disagree.

 

[Fiona]

I am not certain that the situation in the UK is similar to that in the US. We certainly have a big problem with rising house prices, and, as I said before this is largely due to financial liberalisation starting the late 1970's. If it is true that governments directly forced lending institutions in the US to make risky loans that did not happen here and yet the situation appears to be similar in terms of huge indebtedness. So while the differences are perhaps important, in this country at least it seems that the deregulation is directly responsible for the problem in this market.

http://www.housingoutlook.co.uk/Papers/CCI06.pdf

There were several key events in the evolution of financial liberalisation under the Thatcher Government, which came to power in 1979. Exchange controls were removed in 1979, opening the banking sector to greater foreign competition and giving domestic institutions access to the developing Eurodollar markets. This was an important step in integrating the United Kingdom into rapidly expanding international capital markets, discussed earlier. The logical step after removing exchange controls was to abolish the minimum deposit requirement on banks, or ‘corset’ on bank lending. Banks could enter the mortgage market from 1980.

Increased competition in the mortgage market led to the relaxation of rules on building societies (eg their access to wholesale financial markets) and the break-up in 1983 of the interest rate fixing agreements. The Building Societies Act (1986) formalised the relaxation of rules. One consequence is likely to have been charging higher interest rates for more risky loans.4 A second phase of new entry into the mortgage market from 1985 was heralded by the influx of centralised mortgage lenders without high street branches.5
The Basel I Accords on capital adequacy ratios for banks, agreed in 1988, gave mortgage loans a preferred status, with a 50% risk weighting relative to other loans. This may have caused a further easing to the mortgage-lending regime in the United Kingdom.


<snip>

Chart 2 shows consumption to income and house price to income ratios rising strongly in the 1980s. Part of the co-movement is due to credit market liberalisation rather than the causal effect of house prices on consumption as demonstrated by Aron and Muellbauer (2006). Chart 3 shows mortgage and unsecured debt to income ratios more than doubling between 1980 and 1990 and rising to new heights recently.

http://www.housingoutlook.co.uk/Papers/Flib97.pdf

In the UK from 1979, nominal interest rates rose, and foreign exchange controls were abandoned. The “corset” which had restricted bank lending was removed in 1980 and the banks, suffering losses from Third World lending in the 1970s, were anxious to enter domestic mortgage markets. The share of the ‘High Street’ banks in total mortgages outstanding rose from 5.5% at the end of 1980, to 9.1% in 1981, 14.1% in 1982 and 16.2% in 1983 and reached 20.2% by 1988. Mortgage markets thus became much more competitive. Restrictions on building societies were progressively relaxed, particularly in giving them increased access to the money markets so that their lending was less and less constrained by retail savings deposits. This culminated in the 1986 Building Societies Act.

A new breed of mortgage lenders, often financed by overseas banks, entered the market. These raised their market share of loans outstanding from 0.8% in 1985, to 2.3% in 1986, 4.1% in 1987, 6.4% in 1988, 6.7% in 1989 and a peak of 8.1% in 1990. These ‘centralized mortgage lenders’ typically operated through financial intermediaries, having no High Street branches themselves. Credit became so easily available that, between 1985 and 1990, over 20% of first time buyers from building societies were offered 100% loan to value ratios.2 From 1980 to 1989, household debt to income ratios in the UK more than doubled to one of the highest ratios in the world and there was a boom in house prices in which real prices in the UK doubled over the same period. These developments were not solely the result of financial deregulation since there was sustained economic growth and falling unemployment from 1986 to 1990. But it is hard to deny the connection. In the 1990s further changes took place in the regulatory capital regime for mortgage lenders, and in the provision of mortgage indemnity insurance. Furthermore, demutualization of building societies, led by Abbey National in 1989, has made it possible for mutual institutions to switch to the regulatory regime governing banks.

So far as I am aware we have no equivalent of Fannie and Freddie: so I fail to see how the problem can be attributed to interference rather than to deregulation. If there are important reasons to see the two situations as significantly different in this respect I have missed it and will be glad to have it pointed out.

 

[YoPopa]

I'm not inclined to do a bunch of googling to look up the sources I found and/or cited in other threads, but if you are curious, I have found that Janet Yellen is a good source for information. Here's a quote from the first hit I found when I put in "Yellen" and "subprime" into google. It's from a liberal opinion piece, but it quotes Yellen. before making the statements.

I think you may be giving Yellen too much credit Meadmaker.

This is a quote by Thomas J. DiLorenzo

Moreover, Yellen and Gordon don't seem to understand what an "independent mortgage company" is. Many of these companies are like the one in which my next-door neighbor is employed: they are middlemen who arrange mortgage loans for borrowers — including "subprime" borrowers — with banks, including CRA-regulated banks. Some killer statistic.

 

[Meadmaker]

I think you may be giving Yellen too much credit Meadmaker.

I'm fairly confident Yellen knows what a mortgage broker is, and is capable of digesting the statistics related to the CRA. Maybe I'm just giving too much credit to the head of a Federal Reserve Bank, but in the absence of strong reasons to disagree, I'll assume such a person has a clue.

As I said to Saul, I won't disagree that a variety of government initiatives aimed at increasing low income home ownership probably contributed to this problem. I have been trying to figure out exactly what measures constituted President Bush's "America's Home Ownership Challenge".

Democrats and Republicans often pursue the same goals, but their approach is different. Democrats tend to say to business, "If you want to continue operating, we are going to tie your hands and force you to address concerns of low income/minorities/people who tend to vote for us." Republicans tend to say, "The best way to serve all the people, including low income/minorities/etc is to cut out the regulations that prevent them from doing so, and to lower the taxes so that it's more profitable to do so."

The CRA is an example of the former, and doesn't seem to have caused much grief since its inception in 1975. The Republican approach doesn't seem to have worked out so well lately.

 

[Meadmaker]

I am not certain that the situation in the UK is similar to that in the US. We certainly have a big problem with rising house prices, and, as I said before this is largely due to financial liberalisation starting the late 1970's.

Certainly, these trends have been going on a while, and are not completely limited to developments in the US. It seems to me that there has been a general acceptance of the idea that if we let businesses operate more freely, everyone wins.

The problem is that that doesn't always happen. In particular, it seems to me, that technology enabled much more fast paced developments that changed the nature of competition in the financial industry, and the general attitude against regulation prevented leaders from seeing that this was leading to a train wreck.

 

[soylent]

It is regulation that Horwitz is blaming for creating these unintended consequences, perverse incentives which motivate businessmen to do all sorts of risky things, like offer loans without a down payment.

What regulation does Horwitz blame for the, as far as I'm aware, unregulated ~$60 trillion CDS monster that brought down AIG, Lehman, Bear Sterns, Icelands banking system and currency and pushed the worlds credit markets to the brink of seizing up?

 

[Fiona]

Certainly, these trends have been going on a while, and are not completely limited to developments in the US. It seems to me that there has been a general acceptance of the idea that if we let businesses operate more freely, everyone wins.

In the uk this was a quite specific ideological dogma which was controversial when Mrs Thatcher came to power. One of the reasons Scots are unhappy is that this view has never captured the majority here: but it did in England and America and it has been aggressively promoted by business and the media. It started with the adoption of monetarist theory and I have never been able to understand why anybody thinks it makes any logical sense because it is a variation of laissez faire capitalism and this was thoroughly discredited in the early 1930's. I think it was just repackaged. In the 1920's I think we saw the same policies with the same sorts of effects - unsustainable boom on credit and then a big crash. I sincerely hope I am wrong about this but I have read that changes to the regulatory regimes, did in at least some instances, comprise removing safeguards which were originally imposed in the aftermath of the great depression to prevent a repeat of that disaster. We have short memories and we think of short term effects.That is really why I feel it is important to look further back than is generally being done atm, at least in the media here.

The problem is that that doesn't always happen. In particular, it seems to me, that technology enabled much more fast paced developments that changed the nature of competition in the financial industry, and the general attitude against regulation prevented leaders from seeing that this was leading to a train wreck.

I think it is a little unfair to blame politicians alone. They are people like the rest of us, and there is no doubt that the propaganda in favour of this policy proved very persuasive. Much of the electorate were sold on the ideas and there was no effective counter to it in the mainstream media: not least because it results in very high profit and bonus for the business sector in the short term, and much of the media is private sector too: it is hardly surprising that they would promote such ideas. The "general attitude against regulation" did not come from nowhere. That, and the idea that personal taxation is a bad thing was aggressively promoted in both the uk and the us: not so much in mainland europe, though this school of economics did have influence there too. For reasons I am completely unable to understand people accepted this despite the direct evidence in their own lives. Control of the media is much more important than I could have believed possible if I had not seen this process. But at least in the uk it was not the media alone: the business sector was introduced into public service to an astonishing extent and with the destruction of effective trades unions there was no alternative power base and no alternative voice. In fact at the outset the acronym de jour was TINA: one of the biggest lies I have ever seen and proof that Goebels ( I think it was him) was right when he suggested that if you are going to tell a lie make it a big one for best effect.

I think we suffer from an unquestioning acceptance of an agenda which suited the interests of a particular sector. And that is as much the fault of the electorate as of the politicians. I do not suggest the business sector did not believe what they were saying: this is not a conspiracy theory. But it seems to me there was ample evidence both in history, and indeed in the actual effects seen while the policy was being pursued, that there was something profoundly wrong with this thinking. Politicians are culpable, in that they appear to have abdicated any leadership role, and over this period they did benefit directly because their incomes are also high. They are also increasingly isolated from the electorate because of the centralisation of power in a small area where everyone they meet regularly tends to be in a very high income bracket too: politicians, top journalists of various sorts, and company directors and CEO's do not really live in the same world as the rest of us. And the poor, who paid a very high price for all of this, do not have an effective voice

The technology probably had an impact but for me it is the economic theory which is the root cause of the problem and that theory led to the deregulation which was the means

 

[Meadmaker]

And that is as much the fault of the electorate as of the politicians.

Indeed. We have met the enemy, and they are us.

(Since you are a UK citizen, you might not recognize the reference. I don't know if that particular bit of historical trivia is recognized. Following a victory against British naval forces, American Admiral Perry sent a message that read, "We have met the enemy, and they are ours." Cartoonist Walt Kelly famously parodied that statement in a cartoon a few decades back.)

Generally, I agree with what you wrote. Sadly, I don't see a complete reversal of the problems anytime soon, at least not on this side of the pond. Both of our candidates for President are making promises they can't keep even as we speak.

 

[Neally]

The desire to live near green, undeveloped, land is not environmentalist ideology.

You're right it's not, but that's not what's behind growth restrictions. Look who's behind the urban boundary measures and you'll find they are dominated by environmentalists, or, as they are often called, "sustainability advocates."

 

[Meadmaker]

You're right it's not, but that's not what's behind growth restrictions. Look who's behind the urban boundary measures and you'll find they are dominated by environmentalists, or, as they are often called, "sustainability advocates."

Why do I have to look at who is behind things? Why can't I look at what it does? If there's a regulation that says, "You can't chop down all the trees in the county and replace them with strip malls," I supppose that would probably be backed by environmentalists, and opposed by strip mall developers, and those groups would probably pour lots of money into the PR campaign to back the regulation. However, the voters would vote for it, directly or through their elected representatives, because they would rather live near a forest preserve than a strip mall.

Saying that such regulations caused AIG or Freddie Mac to collapse is really, really, messed up.

 

[Neally]

If there's a regulation that says, "You can't chop down all the trees in the county and replace them with strip malls," I supppose that would probably be backed by environmentalists, and opposed by strip mall developers, and those groups would probably pour lots of money into the PR campaign to back the regulation.

And that regulation would be called environmental ideology. The growth restrictions typically do not target strip malls specifically, but has the greatest impact on housing and thus housing prices.

Saying that such regulations caused AIG or Freddie Mac to collapse is really, really, messed up.

No, but it drives up the cost of housing. That, along with all the other factors previously mentioned, contributed to the real estate bubble and subsequent crash.

 

[Fiona]

Housing doesn't have a cost except what people will pay. And that is related to what they can borrow. If borrowing is regulated so that it is related to income, then the prices will not rise so much:because demand is not defined as how many people want a commodity: it is defined by how many people can afford to buy the thing they want. An economist can say with a straight face that there is no demand for food in a country where people are starving, because demand is a term of art in this connection. The links I provided show that the availability of credit is the biggest factor driving up house prices and that is what deregulation achieved: planning regulations are insignificant in comparison

 

[dudalb]

I have been a very strong supporter of the Free Market, but it is now painfully apparent we need SOME regulation of banking .
The whole "Blame Regulation" mantra of the Libertarians is getting little traction. That Dog Won't Hunt.
I think the trick is to avoid going overboard and adapting such heavy regulation that it backfires and banks are afraid to take ANY chances. A balance is needed.

 

[Francesca R]

Housing doesn't have a cost except what people will pay. And that is related to what they can borrow. If borrowing is regulated so that it is related to income, then the prices will not rise so much:because demand is not defined as how many people want a commodity: it is defined by how many people can afford to buy the thing they want. An economist can say with a straight face that there is no demand for food in a country where people are starving, because demand is a term of art in this connection. The links I provided show that the availability of credit is the biggest factor driving up house prices and that is what deregulation achieved: planning regulations are insignificant in comparison

OK so if credit is freely available to hungry people, and not restricted by law according to their ability to pay it back, then they will bid up food prices to bubble heights?

There were asset price bubbles before credit disintermediation. Try again.

 

[Fiona]

Well that is what the evidence seems to say happens FrancescaR. What is you explanation ?

 

[Gord_in_Toronto]

Thanks for this thread guys. I'm following it with great interest even though I don't feel qualified to contribute (please don't tell my wife I said that!).

I'm trying as I go to relate it to what is (and is not) happening here in Canada based mostly on my understanding of the differences between the US and Canadian banking systems I was taught in Grade 9.

I will not mention the CMHC.

 

[SaulOhio]

What regulation does Horwitz blame for the, as far as I'm aware, unregulated ~$60 trillion CDS monster that brought down AIG, Lehman, Bear Sterns, Icelands banking system and currency and pushed the worlds credit markets to the brink of seizing up?

How much money did those institutions get to borrow from the Fed and how many mortgages did they sell to Fannie Mae and Freddie Mac?

Concerning "open space" laws.

Saying that such regulations caused AIG or Freddie Mac to collapse is really, really, messed up.

I'm not saying caused. I'm saying contributed to the high price of housing, which was part of the cause of the collapse. You limit the number of homes that can be built in an area, the law of supply and demand says the price will rise. People saw land prices rising, they saw opportunities to make a quick buck, and invested even more money into real-estate, further inflating the prices. You add in the GSE's and cheap money from the Fed's low interest rates, you have the recipe for exactly what we saw happen.

And, BTW, someone asked for a smoking gun in this mess?

Bill Clinton's drive to increase homeownership went way too far
Posted by: Peter Coy on February 27

The National Homeownership Strategy began in 1994 when Clinton directed HUD Secretary Henry Cisneros to come up with a plan, and Cisneros convened what HUD called a "historic meeting" of private and public housing-industry organizations in August 1994. The group eventually produced a plan, of which Mason sent me a PDF of Chapter 4, the one that argues for creative measures to promote homeownership.

The very worst idea in the plan, which fortunately never gained approval, was to let first-time homebuyers freely tap their IRA and 401(k) retirement-savings plans with no penalty to scrounge up a downpayment. That, HUD estimated, would have "benefited" 600,000 families in the first five years.

Plenty of other ideas in the plan did become reality, though. Knowing what we know now about the housing bust, the earnest language in the document seems faintly ridiculous. Here's an excerpt. Read it closely and you can see the seeds of disaster being planted:

"For many potential homebuyers, the lack of cash available to accumulate the required downpayment and closing costs is the major impediment to purchasing a home. Other households do not have sufficient available income to to make the monthly payments on mortgages financed at market interest rates for standard loan terms. Financing strategies, fueled by the creativity and resources of the private and public sectors, should address both of these financial barriers to homeownership."

A National Homeownership Strategy for the New Millenium

National Homeownership Strategy, prepared by the U.S. Department of Housing and Urban Development (HUD), under the direction of Secretary Henry G. Cisneros, in response to a request from President Clinton.

According to the website devoted to the Strategy initiative at HUD1, “In the
spring and summer of 1994, Secretary Henry Cisneros met with leaders of major national organizations from the housing industry to solicit their views about establishing a national homeownership partnership. In August 1994 these planning sessions culminated in a historic meeting at which industry
representatives agreed to the formation of working groups to help develop the
National Homeownership Strategy,” (The National Homeownership strategyartners in the American Dream, Chapter 1: The National homeownership Strategy).

The Strategy brought together a diverse set of public and private housing
market participants in coordinating an approach to, “…achieve an all-time high
level of homeownership in America within the next 6 years.” The Strategy
included input from, “…private and public sector resources and commitments to implement three broad approaches designed to make homeownership more
affordable, accessible, and available.” Specifically, strategies advocated under
the initiative include:

…streamlining transaction costs, expanding creative financing and public gap
financing, and making technological improvements in loan underwriting [that] will reduce the costs of homeownership…. Regulatory reforms will allow developers and builders to reduce the costs of land assembly, housing construction, and home rehabilitation, making homeownership more affordable for willing homebuyers who are now priced out of the housing market (The National Homeownership Strategy: Partners in the American Dream, Chapter 1: The National Homeownership Strategy).

And MeadeMaker: If you want to call all of this thumbfingered intervention into the market "regulation" or not, it is still government manipulation of the market. But the free market still gets the blame. You said somehting about Bill Clinton speaking about what he MIGHT do, as if dismissing its importance, sine he didn;t actually do it. Politicians talking about what they plan to do can have as powerful and effect as actually doing it. If someone threatens you with violence, it can affect your life and behavior almost as much as if the violence was actually comitted, which is why threatening a person is a crime. Same with government threats, motivating businesses to "self regulate". It is still government interference in the market.

 

[Meadmaker]

National Homeownership Strategy, prepared by the U.S. Department of Housing and Urban Development (HUD), under the direction of Secretary Henry G. Cisneros, in response to a request from President Clinton.

It's interesting that the text you posted was astonishingly similar to "America's Home Ownership Challenge", a Bush administration initiative.

Regulatory reforms will allow developers and builders to reduce the costs of land assembly, housing construction, and home rehabilitation, making homeownership more affordable for willing homebuyers who are now priced out of the housing market (The National Homeownership Strategy: Partners in the American Dream, Chapter 1: The National Homeownership Strategy).[/i]

So, the deregulation didn't begin under Bush.

And MeadeMaker: If you want to call all of this thumbfingered intervention into the market "regulation" or not, it is still government manipulation of the market.

I would have to agree. It's fairly obvious that this market hasn't been "free" for a long time.

On the other hand, the approach to market manipulation seems to have been different, although I'm not absolutely certain of that. The rhetoric of the Republicans calls for letting business do more things. The rhetoric of the Democrats calls for forcing business to do more things. I'm not sure where rhetoric meets reality.

 

[Meadmaker]

streamlining transaction costs, ... and making technological improvements in loan underwriting [that] will reduce the costs of homeownership….

It's interesting to me that this was identified specifically. As I noted before, I suspect the technology of loan underwriting played a huge role in this mess.

 

[MIKILLINI]

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.

I mention Greenspan's name in particular because of the reverence economists, politicians and media bestowed upon him. They virtually regarded him as the smartest banking mind on the planet. When he spoke, people listened because they believed Greenspan knew how the system worked and how to control it.

Greenspan’s low interest rate policy allowed the systemic threat to develop. Low interest rates push up housing prices by lowering monthly mortgage payments, thus increasing housing demand. Rising home prices created equity to justify 100 percent mortgages. Buyers leveraged themselves to the hilt and lacked the ability to make payments when they lost their jobs or when adjustable rates and interest escalator clauses pushed up monthly payments.

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.

You're right, this is an actual regulation. It was a quick response regulation enacted to solve a problem, but the potential problems it could create in the future were not given enough scrutiny.

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.

The excessive leverage problem was/is a huge factor.
In place of time-proven standards of prudence, computer models engineered by hot shots determined acceptable risk. As one result Bear Stearns, for example, pushed its leverage ratio to 33 to 1. For every one dollar in equity, the investment bank had $33 of debt!

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.

To shore up the credibility of the US Treasury’s own credit rating and the US dollar as world reserve currency, the US budget and trade deficits must be addressed. The US budget deficit can be eliminated by halting the Bush Regime’s wars and by cutting the extravagant US military budget. The US spends more on military than the rest of the world combined. This is insane and unaffordable. A balanced budget is a signal to the world that the US government is serious and is taking measures to reduce its demand on the supply of world savings.

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.

It was computer models that led to the failure of Long-Term Capital Management in 1998, the first systemic threat to the financial system. Why the SEC went along with Paulson and set aside capital requirements after the scare of Long-Term Capital Management is inexplicable.
The following year was the repeal of the Glass-Steagall Act.

It was in 2000 that derivatives and credit default swaps were excluded from regulation.

In 2004, the current Secretary of the Treasury, Henry M. Paulson Jr, was head of the investment bank Goldman Sachs. In the spring of 2004, the investment banks, led by Paulson, met with the Securities and Exchange Commission. At this meeting with the New Deal regulatory agency tasked with regulating the US financial system, Paulson convinced the SEC Commissioners to exempt the investment banks from maintaining reserves to cover losses on investments. The exemption granted by the SEC allowed the investment banks to leverage financial instruments beyond any bounds of prudence.

The blame is headed toward SEC chairman Christopher Cox. Cox, like so many others, was a victim of a free market ideology, itself a reaction to over-regulation, that was boosted by academic economic opinion, that the market “always knows best.”

The Paulson bailout saves his firm, Goldman Sachs. The Paulson bailout transfers the troubled financial instruments that the financial sector created from the books of the financial sector to the books of the taxpayers at the US Treasury.

This is all the bailout does. It rescues the guilty.

The Paulson bailout does not address the problem, which is the defaulting home mortgages.