For the next few days, weeks and probably years, we’re going to hear a lot about what caused the financial crisis and led to a $700 bailout. And we’ve already heard presidential nominees, Members of Congress and political analysts blame free markets and deregulatory policies over the past 8 years. Using free markets and deregulation as scapegoats couldn’t be farther from the truth. Let’s see why.
Here’s Sebastian Mallaby’s take:
Financiers did create those piles of debt, and they certainly deserve some blame for today’s crisis. But was the financiers’ miscalculation caused by deregulation? Not really.
The key financiers in this game were not the mortgage lenders, the ratings agencies or the investment banks that created those now infamous mortgage securities. In different ways, these players were all peddling financial snake oil, but as Columbia University’s Charles Calomiris observes, there will always be snake-oil salesmen. Rather, the key financiers were the ones who bought the toxic mortgage products. If they hadn’t been willing to buy snake oil, nobody would have been peddling it.
Who were the purchasers? They were by no means unregulated. U.S. investment banks, regulated by the Securities and Exchange Commission, bought piles of toxic waste. U.S. commercial banks, regulated by several agencies, including the Fed, also devoured large quantities. European banks, which faced a different and supposedly more up-to-date supervisory scheme, turn out to have been just as rash.
By contrast, lightly regulated hedge funds resisted buying toxic waste for the most part – though they are now vulnerable to the broader credit crunch because they operate with borrowed money.
If that doesn’t convince you that deregulation is the wrong scapegoat, consider this: The appetite for toxic mortgages was fueled by Fannie Mae and Freddie Mac, the super-regulated housing finance companies. Mr. Calomiris calculates that Fannie and Freddie bought more than a third of the $3 trillion in junk mortgages created during the bubble and that they did so because heavy government oversight obliged them to push money toward marginal home purchasers.
There’s a vigorous argument about whether Mr. Calomiris’ number is too high. But everyone concedes that Fannie and Freddie poured fuel on the fire to the tune of hundreds of billions of dollars. “
Here’s George Mason economist Walter Williams:
The financial collapse of Fannie Mae and Freddie Mac is not a failure of the free market because lending institutions in a free market would not have taken on the high-risk loans. They were forced to by the heavy hand of government.”
Here’s our own distinguished fellow, former Congressman Ernest Istook:
Greed was indeed a problem, but not just on Wall Street and in the mortgage industry. It also motivated buyers who thought they could get something for nothing. Don’t omit the political greed, although politicians want to mask this by holding hearings about the faults of others but not of themselves. Thanks to politics, our government was not only an enabler, but actually required lenders to issue something-for-nothing loans.
As noted by George Mason University economics professor Russell Roberts, “For 1996, HUD [Department of Housing and Urban Development] required that 12 percent of all mortgage purchases by Fannie and Freddie be ‘special affordable’ loans, typically to borrowers with income less than 60 percent of their area’s median income. That number was increased to 20 percent in 2000 and 22 percent in 2005. The 2008 goal was to be 28 percent.”
The left’s affordable-housing agenda created not just incentives but actual mandates for bad behavior, especially with their political allies running those GSEs. Public outrage stopped the Clintons from taking over health care. But their HUD stealthily sowed the seeds of today’s financial mess.
Government regulation cannot now be the all-purpose answer when it was the source of the problem.”
If you still need convincing, read our Senior Research Fellow in Regulatory Policy, James Gattuso’s “Red Tape Rising: Regulatory Trends in the Bush Years” that shows the regulatory burdens have increased in the years since George W. Bush assumed the presidency.
Going back to Mallaby, he properly warns us by saying:
[B]laming deregulation for the financial mess is misguided. It is dangerous, too, because one of the big challenges for the next president will be to defend markets against the inevitable backlash that follows this crisis.”