April 04, 2009
Over at NRO, Stephen Spruiell has come out in favor of tighter regulation of financial markets, but not because unregulated financial markets cause problems. As Spruiell says, he is now advocating tighter regulation “not because regulation works better than market discipline at curbing excessive risk-taking, but because market bailouts have impaired the market’s ability to function properly.” Spruiell is silent, of course, about how financial markets actually functioned after the passage of the Financial Services Modernization Act of 1999 and the passage of the Commodity Futures Modernization Act in 2000, both of which repealed regulations intended to curb excessive risk-taking, including the Glass-Steagall Act of 1933, which had prohibited deposit-taking banks from acting as investment banks.
This is the language of ideology. There is the “market,” which is good, and “regulation,” which is bad. Since “the market” is, by definition, good, it follows that any problems associated with “the market” must be caused by something else. In the real world, although regulation is often harmful, it is sometimes necessary. As Steve Sailer and others have documented, regulatory pressures applied to lenders were instrumental in creating the subprime mortgage mess.
But what transformed that mess into the massive problem it became was the fact that bad mortgages were “securitized,” a process that was aided by the deregulation of financial markets. As South Carolina law professor William Quirk writes in the February 2009 issue of Chronicles , “There are two crises: One is the ‘troubled asset’ crisis, caused by subprime mortgages. That problem is finite, and should be fairly easy to solve: Either let the losses fall where they may or guarantee the bad mortgages. But amazingly, the total losses from the crisis far exceed the bad mortgages, which brings us to the second crisis—the derivative crisis where ‘sophisticated parties’ bet on anything.” Quirk puts “sophisticated parties” in quotes because he had just quoted Larry Summers, formerly of the Clinton Administration, now of the Obama Administration, telling Congress in 1998 that there was no reason to worry about the explosive growth of derivatives because “the parties to these kinds of contracts are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies and most of which are already subject to basic safety and soundness regulation under existing banking and securities laws.” Oops.
As Quirk also points out, both political parties, which are largely funded by Wall Street, eagerly embraced financial deregulation. The act repealing Glass-Steagall, the Financial Services Modernization Act of 1999, passed the Senate 90-8 and was signed into law by Bill Clinton, who gushed, “Over the past 7 years, we’ve tried to modernize the economy, and today what we’re doing is modernizing the financial services industry, tearing down these antiquated walls, and granting banks significant new authority.” What many banks did with this “significant new authority” was gamble. Citigroup “failed because it did exactly what Glass-Steagall would have prevented: It traded for its own account as if it were an investment-banking partnership.” Indeed, as Quirk notes, the entire derivatives market likely violated state anti-gambling laws until the passage of “The Commodity Futures Modernization Act of 2000,” which expressly provided, in Section 17, that “This Act shall supersede and preempt the application of any State or local law that prohibits or regulates gaming or the operation of bucket shops.” My advice to lawmakers: In the future, do not pass any law involving financial markets that expressly preempts laws against gambling.
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