Regulators and politicians fighting the last crisis

What caused the current financial crisis, and what should we do about it? Cato Institute’s Johan Norberg looks back in history and makes some important observations:

Regulators Cannot
Avert Next Crisis

As usual after a financial crisis, we hear demands for new controls and regulations to stop it from happening again. But since every crisis has led to thousands of new pages of regulation, why is it that regulation doesn’t stop crises from happening again? No matter what pundits say, we are nowhere near a laissez-faire situation. Look no further than the US federal institutions in Washington, DC, and we find 12,113 individuals working full time to regulate the financial markets. What did they do with the powers they had?

Read the entire article here, then return to comment on Catalyst.


Steve Buckstein is founder and senior policy analyst at Cascade Policy Institute, Oregon’s free market research center.

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  • David from Eugene

    In as much as we will not know in what form the next financial crisis will be or its trigger it is unlikely that a set of regulations could be developed to prevent it. Besides, if by accident we were successful in crafting regulations to prevent the next crisis we would not know we did because that crisis would not happen. What we can do and should do is craft a set of regulations that would prevent a Crisis similar to the current one from happening again.

    As we draft these new regulations we need to remember that the global financial market place is a dynamic ever changing system. Which means that we need to revisit the regulations on a periodic basis to insure that they are working in the manner intended and getting the desired results and if necessary to tweak the regulations to avoid undesirable effects.

    Basically, “Mark to Market” is good policy, it is much superior to allowing any value to be assigned to an asset by the institution holding it. But as the present situation shows there is a problem when for what ever reason there is a rapidly fluctuating market or no market price to use. So clearly we need to make adjustment, possibly allowing the rule to be temporarily suspended by the Federal Reserve Chair, SEC Director and Secretary of Treasury operating together. What we should not do is junk the rule.

    Similarly, Sarbanes-Oxley Act of 2002 is not perfect but it is better allowing companies to lie to the public. If it is causing real problems it may need to be adjusted.

    A careful examination of the current crisis shows that an unregulated mortgage market is at the root, a market that rewarded abuse and punished prudence. The other important thing this crisis points out is that while there are no firms to large to fail, there are firms that are to large to be permitted to fail. Both problems should be addressed through carefully crafted regulations.

  • Anonymous

    from my observations, The government should get out of the way and let the market manage themselves. If they had not decided to see that everybody owned a home, which is a nice thought, much of this wouldn’t have happened.

    Over the last several years, I’ve seen home prices going through the roof, Kind of like the stock market to see how much return you could get on your money. That’s fine if you have the money to play that game, but so many homeowners didn’t and don’t.

    I just saw a family of four with an income of less than $10,000 per year being approved for subsidy to purchase a $180,000 home. I saw the paperwork so am not just picking numbers out of the air. Even with subsidy, this family probably won’t be able to make it.

    There are so many other things to help them if that’s somebody’s desire, saddling them and the taxpayer with debt like this is a recipe for disaster like we are seeing now

    • David from Eugene

      The government influence on this crisis was minimal. This Crisis is the result of an un-regulated market run wild not government regulation. One of the problems we are facing globally is that the world’s financial markets are so interwoven that a local crisis like the one we are having with Sub-Prime Mortgages has the potential to crash everything. Hence the need to have some form of regulation, the question is created by whom, in what form and regulated by whom.

      • Crawdude

        Wow! David, I think we’ve found something we both agree on.

  • Crawdude

    Just to clarify, the below is the part of your statement I agree with. The 1997 law that was passed by the GOP legislature and DNC President mandated that the banks HAD to find loan vehicles that high risk people could get. That law IS a regulation, therefore Bad regulation was a crucial portion of this crisis. No regulation, not deregulation was another crucial part.

    This is the part I agree 100% with 🙂

    “One of the problems we are facing globally is that the world’s financial markets are so interwoven that a local crisis like the one we are having with Sub-Prime Mortgages has the potential to crash everything. Hence the need to have some form of regulation, the question is created by whom, in what form and regulated by whom”.

    • dean

      Dude…its not cause and effect. To make a cause and effect between regulations that pushed lenders to be more forthcoming with loans to poor people, you would have to show that there were so many of these loans made they tipped the system over. And its just not the case. The tipping was from the investment banks and their lending methods, which were not, I repeat NOT afected AT ALL by any government policy aimed at helping poor people buy homes. This is pure myth.

      • Anonymous

        Astounding. You know even less about finance than you do about everything else.

      • Crawdude

        Lol, yeah, okay Dean……..

        • dean

          I’m a credit union member and have been for over 20 years. I was curious as to what role credit unions have played in this financial fiasco. I have not heard of ANY credit unions having gone crazy with subprime loans or going bust. So I did a bit of surfing.

          The CRA does not apply to credit unions. Now that might suggest they have stayed above the fray by not loaning money to poor people, but it turns out the opposite is true. They loan way more money to poor and middle income people for home mortgages, but at the same time they are dilligent about their loans. THeir aproval rate for low and moderate income home buyers is 69%, while commercial banks and S&Ls approve only 47% (2006 data).

          In other words, loaning money to lower income prople to buy homes is not the problem. But you have to loan them the right amount under the right terms. I suspect the credit Unions have done well through all this mess because they are non-profit. They exist to serve their members, not to make a buck for investors. Since they don’t need to make a lot on loans, they tend to hold them rather than re-sell them, so they avoided the whole bundling game. They are in effect socialist institutions. Ironic isn’t it?

          • Crawdude

            Yeah, um, okay Dean. Nice attempt to get out of your earlier proclamation.

            I agree, Credit Unions are more disciplined in their loan practices. I am a member of one myself. They don’t offer no interest loasns to losers, they don’t allow people to buy more than they should be able to.
            Thats not socialism, thats good business decisions.

            Socialism is mandating that people who don’t qualify must still be given a loan.

            They also only make up about 4% of the lending institutions in this country. They also were not mandated by the GOVERNMENT to give every high risk, low income applicant a loan for a house they couldn’t afford.

            Other than trying to put a smoke screen over your original incorrect statement , your credit union comment was so far off the subject and facts so liberally twisted as to render it useless for any real contemplation.

  • Anonymous

    Read the letter and note the third signer.

    https://www.humanevents.com/article.php?id=28973

  • Rupert in Springfield

    The article by Norberg is a good one. It points out the perils with a partial command economy as opposed to a laissez fair one in a pretty concise manner. The markets are reacting in exactly the way he would predict.

    At this point few would argue with the fact that for the most part government got us into this mess by muscling banks to lend with political consideration in mind, not financial. That has resulted in a tremendous loss of faith in government and we are seeing it now. Passage of the bailout package has resulted in a straight downhill plunge in the stock market and little but anger and rage in the populace. Treasury secretary Paulson’s protestations do little to cement confidence. Right now the only companies doing any good business are those that make either pitchforks, torches, or broken bourbon bottles.

    I’m sorry Mr. Paulson, your comments that none of the bailout funds have been disbursed do nothing to quell, and everything to exacerbate , fears that the economy is not something the government is equipped to deal with. There was some sort of emergency that required the bailout package be passed with due speed. Yet once it was, there was no ground plan for the funds? Please tell us how you arrived at the $800B figure then, when only now are you considering where the funds should go? Please tell us exactly why it was so urgent to pass the bill, but not urgent for you to have an action plan in place to be implemented upon passage.

    None of this is very confidence inspiring. One would hope that given this latest debacle the populace is rapidly learning some of the deleterious effects of command economies. Given the strength of the dollar it would appear that despite our folly in this realm, the rest of the world has more confidence in us, than their own economies. Perhaps people are learning in that regard. There is nothing more distasteful than politicians attempting to run an economy, nor more ludicrous than their attempts to fix one. Given that vast swaths of capitol hill are inhabited by people who have never had a job, nor run a lemonade stand, we can only wonder what sort of thoughts run through their minds when trying to figure out peoples lack of confidence in them. Anyone who bought and sold real estate over the last decade has noticed the progression, I mentioned my own experience and sounded my own concerns here a year ago. I would think that if I could figure it out then, most could now. If they can not, then I am sure that the added little cherry of some 5 million illegal aliens getting mortgages would make things quite clear. Thanks FDIC! Nothing says you are acting in my interest like pressuring banks to make loans to criminals and then asking me to insure them.

    • dean

      Rupert…you have descended into fantasy land. “Command economy?” You think the US is a “command economy?” Interesting. I’m trying to think of the last command I got from government telling me what to buy, where to work, what to grow on my farm, etc…Can’t think of any, yet I check my mailbox, inbox, and phone messages every day.

      Paulson’s plan may or may not work. We can’t judge it after it is in effect a week, or maybe you can but I can’t. I’m inclined to think the better option is direct re-capitalization along with public share ownership, and that looks like where things are going to go next. A significant socialization of our financial industry, under a Republican administration no less. Who would have thunk it?

      “Strength of the dollar?” You are kidding about that one right?

      And FDIC does not insure home loans. They insure deposits. I don’t believe that pressure banks to loan money to criminals, as you state, but I may have missed something.

  • Rupert in Springfield

    I have told you elsewhere I am not going to indulge you in your childish inability to read a simple sentence.

    Any person who cannot read, as you demonstrate with your third sentence, and your lack of comprehension of what I said regarding the FDIC, simply proves they are really not to be taken seriously. Your “strength of the dollar” comment demonstrates that not only can you not read my comments, you simply can not read much of anything. Anyone as unaware of the recent situation with the dollar has nothing to say on financial matters that I would find worth much consideration.

    Until you can demonstrate to me a more mature attitude I really see no reason to debate you. Its boring. Pointing out your reading errors was a job for your momma. It is not my responsibility to give you such instruction now.

    Sorry to take the harsh tone but if you act like a lazy child who cannot read, don’t expect me to debate your mis-readings. Instead learn to be treated like a child, which at this point you quite deserve.

    • dean

      Rupert…one can only conclude from this nonsense that you are afraid to debate, so you rely on insults and avoiding the issue. Why you are afraid, I don’t know, because no matter the topic or merits of one’s arguments, you inevitably declare yourself the victor. But whatever. Have a nice evening.

      • Rupert in Springfield

        Sorry, I just simply don’t have any more interest in dealing with someone who is so childish as to think poor reading is a debate tactic. Beating you on that basis was fun to a point, But frankly I am bored with it.

        In addition I think I made pretty clear that your last little bit of racializing was distasteful to me. That little display of yours made clear I was dealing not only with an immature debater, but essentially a hateful person. I frankly thought it was ugly and I just really don’t want anything more to do with you. You can take that as insult or not, I really don’t care one way or the other.

  • Keith

    The truth is I don’t really understand what caused the crisis and sure don’t know what will fix it — sadly I think that most of the people in DC are in the same boat. They are groping around in the dark for a solution.

    I was taking a survey the other day . . .

    https://www.friendsoftheuschamber.com/takeaction/index.cfm?ID=33

    — and it made me realize that I really don’t expect the economy to get better for at least a year, maybe two.

    Not sure what I would do if I were in congress, but it’s a safe bet i would stop giving away money we don’t have.

    • Crawdude

      Apathy and political stupidity from both our politicians and our citizens is the true cause; as you can tell by the trivial ranting on this page and many others.

      Even as our economy tanks, we still argue the mundane. Our politicians did not put one fix into the alleged bail out bills to stop the mandated bad lending rules. Heck, even the ones running for President are still flinging around their pre-collapse ideas and promises ( most of which will no longer work due to it, do they have anything new?).

      Our market has dropped close to 50%, it pretty much has bottomed out. Paulson will now spend the peoples money to bail out his rich bankers buddies by buying the toxic loans and derivatives………….and laughably claim that the plan worked.

      Congress will reconvene and pass a stimulus plan that benefits no one while not addressing the issues that got us in this mess. 20 years from now we will have an even greater collapse than the current one because of it.

      The ripple effect of this collapse and the still paralyzed credit industry will soon be felt by the increase in the unemployment rates. The estimatesd before the crash were 8.5% by next summer, I’m not sure what it will be now :(.

      As for government reining in its spending and foriegn aid wastes of money……………..Fat Chance, lol!

  • John in Oregon

    My post from another thread is relevant here. I agree with several comments made here by David in Eugene and I will comment on those later.

    While dismissing the effects of the CRA David in Eugene said > *In some circles the “Community Reinvestment Act of 1977” has been identified as being a regulation that forced banks to issue risky loans causing the Sub-Prime Crisis. That is not the case. First, as Dean has pointed out several times, the CRA only applied to Banks and Thrifts which have FDIC coverage; and not the organizations issuing the bulk of the Sub-Prime Mortgages. Second, It does not require Banks and Thrifts to issue risky loans.*

    I would point out that the relevant act is the CRA as _amended in 1995._ David is actually making two claims here. First that front line lenders and realtors were not subject to CRA and therefore the CRA can not cause anything.. Second that CRA does not require risky loan practices. The implicit conclusion of this is that Fannie and Freddie or similar institutions did not make the bad loans.

    I contend the few facts presented are accurate, incomplete and result in an erroneous conclusion.

    Lets follow a buyer through the process to see how the process works. John and Sally, J/S for short, wish to buy a home in the inner-city of Portland. J/S as buyers contact a Realtor. The Realtor or J/S contact a Mortgage Broker who forwards the loan application to a Lender such as Countrywide.

    The logic argued is that since neither the Realtor or the Mortgage Broker are “regulated” the CRA cannot influence what the realtor or broker do.

    That’s theory, what occurred in practice, now that is what matters. Simply put every lender who felt CRA pressure to increase high risk minority loans had only to make it clear that to do business the lender required brokers and realtors increase the numbers of minority loan applications.

    David quotes the > *The purpose statement for the CRA* to suggest that the CRA does not push lenders to make risky loans. Again, that’s theory and what occurred in practice is what matters.

    One aspect of the CRA is the CRA score each lender earned based on the lending rate to low income minority borrowers. Although not precisely a quota the effect is hardly different when the score depends on the level of risky loans.

    And the pressure didn’t stop with the CRA score. Federal lending manuals stated:

    _”Did You Know? Failure to comply with the Equal Credit Opportunity Act or Regulation B can subject a financial institution to *civil liability for actual and punitive damages* in individual or class actions. Liability for punitive damages can be as much as $10,000 in individual actions and the lesser of $500,000 or 1 percent of the creditor’s net worth in class actions.”_

    A challenge immediately taken up by the Association of Community Organization for Reform Now (ACORN) and others filing green line lawsuits against Wells Fargo, Citibank, US Bank, and Others.

    Green line lawsuits were hardly the province of activist organizations. No less that Andrew Cuomo at HUD also used this tool to force lender compliance.

    A situation summed up by Ralph Alter a mortgagee broker in Detroit. Ralph recounted s series of exchanges with various different Countrywide Underwriters for paperwork in which the borrower specifically checked that he did _not_ wish to share ethnic or racial information in the government tracking section of the form.

    Those exchanges with the CW Underwriter ended in the following;

    “Well, you saw him and you know his race and ethnicity. *Our ability to fund our deals and source new money depends on doing a certain percentage of loans with black and minority clients. If you want this loan underwritten at Countrywide, you need to furnish this information:* Is he black?”

    Alter concludes

    “The emphasis on minority lending is readily apparent, even at the expense of the applicant’s stated desire not to furnish this information. As Countrywide became one of the first and most obvious dominoes in the collapsing Rube Goldberg mortgage apparatus, the need for an investigation of the relationship between Fannie Mae and Countrywide seems abundantly clear, to determine the extent of racial strong-arming”

    This, the CRA, wasn’t the only force in play.

    An October 13 article, SPREADING THE VIRUS, in the New York Post describes the roots of today’s economic crisis beginning in 1995. “That March, House Speaker Newt Gingrich was scheduled to address a meeting of county commissioners … some 500 protesters from the Association of Community Organizations for Reform Now (ACORN) poured into the ballroom … demonstrators chanting, “Nuke Newt!” and “We want Newt!” Jamming the aisles, carrying bullhorns and taunting the assembled county commissioners, demonstrators swiftly took over the head table and commandeered the microphone, sending two members of Congress scurrying.”

    The Post continues

    “Editorial writers from Little Rock to Buffalo condemned ACORN’s action as an affront to both civility and freedom of speech.”

    As the article describes;

    “Two days later, 50 to 100 of the same protesters hit their main target – a House Banking subcommittee considering changes to the Community Reinvestment Act, a law that allows groups like ACORN to force banks into making high-risk loans to low-credit customers… The CRA’s ostensible purpose is to prevent banks from discriminating against minorities. But Rep. Marge Roukema (R-NJ), who chaired the subcommittee, was worried that charges of discrimination had become an _excuse for lowering credit standards._ She warned that new, Democrat-proposed CRA regulations could amount to an _illegal quota system. “_

    “FOR years, ACORN had combined manipulation of the CRA with intimidation-protest tactics to force banks to lower credit standards. Its crusade, with help from Democrats in Congress, to push these high-risk “subprime” loans on banks is at the root of today’s economic meltdown. When the role of ACORN and congressional Democrats in the mortgage crisis is pointed out, Democrats reply that _banks subject to the CRA represent only about a quarter of the loans that led to our current troubles. In fact, the problem goes way beyond the CRA.”_

    “..ACORN … campaigns against local banks, quickly hit a roadblock. Banks would tell ACORN they could …reduce their credit standards by only a little – since Fannie Mae and Freddie Mac, the federal mortgage giants, refused to buy up those risky loans for sale on the “secondary market.”

    “So ACORN’s Democratic friends in Congress moved to _force Fannie Mae and Freddie Mac to dispense with normal credit standards._ Throughout the early ’90s, they imposed ever-increasing subprime-lending quotas on Fannie and Freddie. ”

    In some circles the desire is to pronounce markets guilty and acquit Government intervention. For those I ask this simple question. If the CRA and lax lending standards are ineffective and do not increase low income burrowing, why then all the intimidation-protest tactics?

    Dean we all keep playing old CDs. Our current problem has little to do with the housing bubbles. It had everything to do with the credit bubble. You did mention the real problem but didn’t connect the dots.

    > *1: Global financial networks that could move capital around quickly and freely.*

    Moving money quickly is not new. In 1960 the old TELEX network at 50 baud moved money only slightly slower. What is different is financial institutions are no longer isolated within national borders.

    > *2: Absurdly low interest rates, making other safe investments (T-bills) unatractive (sic).*

    At first blush this does appear to be a factor. In reality it’s minor. Low prime interest rates keep all rates low not just mortgagees. Higher interest return rates are indicative of higher risk. “Safe investments” such as T bills have lower returns.

    > *3: Creation of the new funding and bundling strategies that bypassed traditional mortgage lenders.*

    BINGO

    The NY Times article you referenced has a number of deficiencies, just the same that article did get this right.

    “Fannie [and Freddie] never actually made loans. It was essentially _a mortgage insurance company,_ buying mortgages, keeping some but _reselling most to investors_ and, for a fee, _promising to pay off a loan if the borrower defaulted.”_

    This is precisely the mission for which the GSEs Fannie and Freddie were created. The NYT article continues with more detail;

    “Fannie, a government-sponsored company [GSE], had long helped _Americans get cheaper home loans_ by serving as a _powerful middleman, buying mortgages from lenders and banks_ and then holding or _reselling them [as mortgage backed securities] to Wall Street investors._ This allowed banks to _make even more loans — expanding the pool of homeowners.”_

    Expanding the pool of homeowners is a laudable goal, but not at the expense of the stability of the financial system.

    Dean you keep chanting “the Republicans did it. The Republicans did it.”

    At worst that’s an intentional distortion, otherwise known as a Democratic Party talking point. At best it’s sloppy logic that contends;

    *O* Republicans are conservative. (Flawed premise number one.)
    *O* Republicans have ruled in recent years. (Flawed premise number two.)
    *O* Everything wrong in that time is therefore due to conservatism.

    The good old post hoc ergo propter hoc fallacy, even if based on good premises. It is always fallacious to suppose that there is a causative link between two things simply because they coexist.

    But that is now old tapes. Despite repeated warnings, the explosion of the sub-prime bundling bomb has rent asunder financial institutions. Dealing with the cause of the sub-prime mess will only stop us digging the hole deeper.

    The task today is to deal with the liquidity problem, the fallout of the explosion of the sub-prime bomb. The free fall of the stock market is a different problem.

    Consider what has happened in the last ten days. Ten days ago, delayed by partisan political advantage, the bailout bill finally passed. And nothing happened.

    Early last week commercial paper was added to the “solution”. Nothing happened.

    Mid week a coordinated worldwide interest rate cut. Nothing happened.

    At the end of the week the Government began buying interest in banks to inject liquidity. Nothing is happening.

    Might not it be time for the Government to stop spending money it doesn’t have?

    • dean

      John, when I say (if I said) “the Republicans did it…” my meaning is they are going to be held POLITICALLY responsible for the economic preformance during their time in power. Just like Carter is still held responsible for the bad economy under his administration. It may be fair or unfair, but the voters are not going to pin this on Barney Frank, no matter how hard conservative writers try. You can see that in the current polls. Its better to just accept the responsibility, swear you learned from it, and get on with things.

      If Republicans are NOT conservative, they have been lying about their politics for a good long while. Every candidate for the presidency in the R primaries swore he was the next incarnation of Ronald Reagan.

      Republicans had complete control of the federal government from 2001-2006. They had partial control the 7 years prior and 2 years after. The housing bubble dates are generally accepted as 2001-2006. So do the math.

      Is everything wrong during that time the fault of Republicans and therefore conservatives? Of course not. But it would have been far worse had the 44 democrats in the Senate not stood up against privitizing social security.

      Look John…the Iraq war was a Republican led war partly enabled by Democrats. The housing bubble and financial collapse was (my opinion) a case of out of control, deregulated capitalism, pushed by Republicans and enabled by some Democrats. The doubling of our national debt occured under Republican rule. The economic stagnation of the lower 2/3-3/4 of our population accured in the same period. The increase in poverty, the decrease in the number of people with insurance, the loss of prestige overseas….its a long list. Post hoc ergo my foot.

      “Might not it be time for the Government to stop spending money it doesn’t have?”

      No on 2 counts. First, the government is spending money it does have, albeit borrowed money. (If I borrow $10K then that money is now mine. I do have to pay it back later, as does the government). Second, if they don’t spend freely the risk is a serious deflationary spiral like the Japanese experienced after their asset bubble burst. Its very hard to get out of a deflationary spiral, and the only known way out is printing money. Its cheaper and more prudent to print in advance and avoid unecessary pain.

  • John in Oregon

    I find I agree with David in Eugene. I want to go into more depth of subjects that are worthy of more thought. David said > *In as much as we will not know in what form the next financial crisis will be or its trigger it is unlikely that a set of regulations could be developed to prevent it. Besides, if by accident we were successful in crafting regulations to prevent the next crisis we would not know we did because that crisis would not happen. What we can do and should do is craft a set of regulations that would prevent a Crisis similar to the current one from happening again.*

    This has a lot of the feel of Rumsfeld’s known unknowns explanation the media loved to chortle and poke. We cannot know what didn’t happen and we guess at what might happen, and if what we thought might happen doesn’t can we know why it didn’t. It all sounds very philosophical. Master tells Grasshopper, don’t think of the White Horse. That’s a reference to an old TV show for those that may not know.

    Philosophy is nice and all but lets simplify. So in simple terms, no significantly complex system can be optimally controlled centrally. What we should do I will come to later.

    David showed > *Basically, “Mark to Market” is good policy, it is much superior to allowing any value to be assigned to an asset by the institution holding it. But as the present situation shows there is a problem when…*

    I view “mark to market” as a tool. In its basic form, we value stuff by comparing our stuff with other similar stuff that was sold recently. We, our friends, and neighbors do that every day. The blue book for used cars is but one example.

    David also pointed out that sometimes tools don’t work. What are the “Dead Sea Scrolls” worth when nothing like them have been sold? What is a bushel of wheat worth that “might” be contaminated with mold?

    David mentioned > *Similarly, Sarbanes-Oxley Act of 2002 is not perfect but it is better* [than] *allowing companies to lie to the public. If it is causing real problems it may need to be adjusted.*

    Some of the problems David is referring to are the constitutionality of the way Sarbanes-Oxley was implemented. Notwithstanding those questions, my view is, in the wake of Enron and Globalcrossing, the goal of Sarbanes was to provide a consistent method of reporting company performance. The goal was and is honest reporting of performance.

    I totally agree with David’s comments that > *Which means that we need to revisit the regulations on a periodic basis to insure that they are working in the manner intended and getting the desired results and if necessary to tweak the regulations to avoid undesirable effects.*

    I would take this further. The goal should be at least three fold.

    *O* To remove regulation that no longer serves a useful purpose.
    *O* To change regulation that distorts the normal function of markets.
    *O* To strengthen regulation when necessary to prevent gaming or manipulation.

    When Politicians and Bureaucrats talk about regulation the mean the later. Stronger, more regulation. They never acknowledge the first two, that would diminish Government Bureaucratic power.

    Now we come to the point at which David and I depart company. David said > *A careful examination of the current crisis shows that an unregulated mortgage market is at the root, a market that rewarded abuse and punished prudence… The government influence on this crisis was minimal. This Crisis is the result of an un-regulated market run wild not government regulation.*

    I suspect that David would agree that the markets were not functioning normally. The normal hesitancy to lend to borrowers with few prospects of repayment was not operating.

    BUT, is that due to LACK OF REGULATION?

    The ample public record clearly shows the resistance of Banks and Lending Institutions to making those loans. Yet loans were being made that were against the self-interest of the lenders.

    This was not caused by lack of regulation. It was caused by forces external to the markets which distorted the market operation and suppressed lenders self interest.

    I contend those forces were Government and “social justice” green line lawsuits. If anyone wishes to identify different forces such as greed, feel free to show the evidence of how self interests of lenders was suppressed.

    The goal, increased minority home ownership is laudable. The pressure for low income minority lending was intense, and yet it was not sufficient to bring down the financial system.

    David mentioned Sarbanes-Oxley. We hear that name often without knowing why it exists. Three companies, Enron and Globalcrossing, cooked the books of their profit and loss statement. In short both lied to the public about their financial condition.

    Everyone knows Enron, few know Globalcrossing, and the third remains unreported beyond the dark bowels of the legacy media. For those wondering about the invisibility of Globalcrossing simply follow the money and who profited prior to the Globalcrossing crash.

    And the third? That came after Enron/Global and in the face of Sarbanes-Oxley. An enterprise that cooked the books worse than Enron. We have come full circle to Fannie Mae and Franklin Raines.

    What should regulation look like?

    I contend the proper role of regulation, oversight, is policing business to make sure that, when business makes decisions, it does so honestly. Government’s more natural and appropriate role of policing business to maintain honesty. To punish unethical behavior

    In contrast, many politicians, reporters in the legacy media, and non-profit organizers view the role of regulation as promoting “social justice.” Everything they say and report is filtered through that prism.

    Our job is to understand those two concepts are hugely different from each other. Because nobody’s articulating this difference, politicians and the media are getting away with conflating the terms, muddying the waters.

  • David from Eugene

    John

    You raise a number of good points; particularly your expansion of my call for regularly revisiting regulations.

    *O To remove regulation that no longer serves a useful purpose.
    O To change regulation that distorts the normal function of markets.
    O To strengthen regulation when necessary to prevent gaming or manipulation.*

    These are right on the money and do need to applied to all laws and regulations.

    I do differ with your contention, quoted below, that making a risky loan is against the best interest of the participants in the un-regulated loan market.

    *“I suspect that David would agree that the markets were not functioning normally. The normal hesitancy to lend to borrowers with few prospects of repayment was not operating.

    BUT, is that due to LACK OF REGULATION?

    The ample public record clearly shows the resistance of Banks and Lending Institutions to making those loans. Yet loans were being made that were against the self-interest of the lenders.”*

    While I agree the markets were not functioning normally. But in the case of the non-regulated loan market making the risky loans *was not against the best interest* of the mortgage broker, or the lender. At each step they were paid for the loan. The broker got a commission for originating the loan from the lender. Once the broker gets his commission he has no further responsibility for the loan. The lender was paid when the mortgage was bundled and sold. And with the sale the downside of issuing a risky loan the chance of default is passed on to the new holder of the loan. Since a larger number of loans results in more money in the form of commissions and fees and the risk of default is passed on to others making the maximum number of loans possible is in their best interest. And as long as a risky loan is not likely default before it is bundled and sold it is their best interest to make it.

    In addition, many of the “risky” loans were not as much “risky” at the time of issuance as represented the buyer gaming the system, that is taking out a Adjustable Rate Loan with an initial payment that the borrower could handle with the expectation, supported by market history, that the value of the house would increase enough before the loan adjusts that the house could be refinanced with more favorable terms. As long as the price of homes went up there was no problem. And since a refinance also generates a commission for the broker and quick profit for the lender, encouraging and facilitating repeat customers is in their best interest. Besides until the housing bubble popped gaming the system worked.

    As to the CRA and Equal Credit Opportunity Act, they in and of themselves do not force or even encourage risky loans and in the case of the CRA contain language. But it is easy to see that a “bean counter” at a lending institution might decide that issuing risky loans is cheaper or easier then defending a sound lending criteria system in court. Particularly as there is no down side to doing so, as the firm would have taken its cut of the transaction and passed the loan up the chain long before any default.

    The problem behind the “risky loans” is that the un-regulated loan system separated the risk and the reward for loan brokers and lenders such as they got the reward from making the loan without risk. A solution is through regulation re-link risk and reward for all parties in the loan issuance process. By doing so it would again be in the best interest of the broker and lender that the borrower be able to repay the loan.

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