Mortgage Crisis Shows that Government Regulation Doesn’t Work

Glenn Jacobs
Campaign For Liberty
Tuesday, Nov 3rd, 2009

Headlines like this drive me nuts: Mortgage Crisis Shows Why Financial Regulation is Needed. Yes, regulation is needed. Market regulation, that is. At every turn, the government and its accomplices in the financial industry–the politically-connected players–have undermined the free market’s ability to self-regulate. But, of course, this is not the sort of regulation to which the author is referring. No, the market is to blame and our benevolent protectors in government must come to our aid through enlightened regulation.

The one question that no one seems to ask about this whole debacle is: where did the money come from? Where did the banks get the money to create exotic derivatives and engage in shady lending practices? What fuels economic bubbles? The answer, of course, is the government printing press.

Economic bubbles are the result of an inflationary monetary policy. After all, if the amount of money were to remain constant, one sector of the economy could only grow (or in the case of a bubble, explode) at the expense of another sector. For instance, if more money goes into the housing market, driving up housing prices, less money is available to go somewhere else, which will result in lower prices in that sector. This has not been our experience with economic bubbles. While some prices rise more than others, the price of nearly everything goes up. Simple logic tells us that that can only happen if there is more money available.

However, the entire McClatchy article never addresses this point. Instead, the author claims that the cause of the economic meltdown was “30 years of a national political culture that damned government regulation and celebrated unfettered markets.” Yeah, unfettered markets.

How can one reconcile the fact that the money supply is controlled by a monopolistic central authority–the Federal Reserve System–with any sort of free market ideology? I guess that in a world where George “I abandoned free market principles to save the free market system” Bush is held up as the apotheosis of free maket disciples, we should not be surprised. In a real free market, the Fed–at least as anything other than a central clearing house–nor any other central planning body would exist.

Of course, our unfettered market is also subject to numerous government regulatory agencies. You’ve got the FDIC, the SEC, the Commodity Futures Trading Commission (CFTC), the FTC, the National Labor Relations Board (NLRB), the Small Business Administration (SBA), the United States International Trade Commission (USITC), the Federal Housing Finance Agency (FHFA), and the Federal Energy Regulatory Commission (FERC) to name a few. All of these agencies are independent of the executive (regulatory) branch. Agencies within the executive branch itself include the Office of Fair Housing and Equal Opportunity (FHEO), the Office of Community Planning and Development (CPD), the Office of Healthy Homes and Lead Hazard Control (OHHLHC), the FHA, the Government National Mortgage Association (Ginnie Mae), and the Office of Public and Indian Housing (PIH). And that’s just the Department of Housing and Urban Development. Unfettered markets? Give me a break!

Because so few individuals, especially those in the media, understand what “free market” really means, the term “deregulation” has morphed to mean re-regulation. Usually “deregulation” specifically refers to the Gramm-Leach-Bliley Act of 1999 which repealed the part of the Glass-Steagall Act of 1933 that prohibited banks from engaging in both commercial (deposit) banking and investment banking.

While many in the media praise Glass-Steagall as an example of good government regulation, the truth is more complex. In fact, the effect of Glass-Steagall was to weaken, not strengthen, the banking system during the Great Depression. As Jim Powell writes in his great book FDR’s Folly, it was the strong banks which engaged in both commercial banking and investment banking. These were the very banks at which Glass-Steagall was aimed. In other words, at a time when banks were failing by the hundreds, the government attacked those banks who managed to keep their heads above water. Makes great sense.

In addition, while the Pecora hearings are revered in American mythology, they were, in reality, a witch hunt. The Pecora Commission claimed that conflict of interests and abusive bank practices, i.e. banks underwriting and selling unsound securities to their depositors, helped cause the Wall Street Crash of 1929. Glass-Steagall was designed to prevent this from happening again. However, according to Powell, the Pecora Commission did not provide any evidence that securities underwriting imperiled depositor savings. Nor did the banks market the securities they had underwritten to their depositors. The abuses that had taken place were personal in nature, like bank officials intermingling their personal affairs with those of the bank and company.

Ironically, Ron Paul, a champion of free markets and the leading proponent of true deregulation in Congress, voted against the repeal of Glass-Steagall. Paul recognized that Gramm-Leach-Bliley was not deregulation but re-regulation, removing regulations but leaving government subsidies and privileges intact. Writing in 1999, Paul said:

* Government policy and the increase in securitization are largely responsible for this bubble. In addition to loose monetary policies by the Federal Reserve, government-sponsored enterprises Fannie Mae and Freddie Mac have contributed to the problem. The fourfold increases in their balance sheets from 1997 to 1998 boosted new home borrowings to more than $1.5 trillion in 1998, two-thirds of which were refinances which put an extra $15,000 in the pockets of consumers on average–and reduce risk for individual institutions while increasing risk for the system as a whole.
* The rapidity and severity of changes in economic conditions can affect prospects for individual institutions more greatly than that of the overall economy. The Long Term Capital Management hedge fund is a prime example. New companies start and others fail every day. What is troubling with the hedge fund bailout was the governmental response and the increase in moral hazard.
* This increased indication of the government’s eagerness to bail out highly-leveraged, risky and largely unregulated financial institutions bodes ill for the post S. 900 future as far as limiting taxpayer liability is concerned. LTCM isn’t even registered in the United States but the Cayman Islands!

The free market is the most effective regulator. Government policy has prevented the market from regulating itself. Meanwhile, the media has characterized fascistic government policy changes as deregulation, poisoning the well for free market advocates. Sadly, those who advocate government regulation will be sorely disappointed when they realize (if they will admit it) that government regulations are not designed to protect the average American but the interests of the politically-connected and powerful.

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7 Responses to “Mortgage Crisis Shows that Government Regulation Doesn’t Work”

1. moose Says:
   November 3rd, 2009 at 1:34 pm

   I love that “unfettered market” nonsense. Unfettered markets are a boogie-man invented by a communist. World-wide facism would never allow and certainly does not allow in this country, such a thing to exist. Eleven hundred pages of regulations on the health care industry are currently proposed on top of the zillion pages that already exist. Not to help you, to help the owners of the system. Point to a place on the map of the world where unfettered capitalism exists. Right next to Atlantis.

   

   pitofdoom Reply:
   November 3rd, 2009 at 4:46 pm

   400,000 more words of bureaucracy at 2.4 million per word seeks to limit
   “We the people” NOT Corp/Govt. And tells ALL whom they’ll be fighting for their lives!!

   Become one with Tyranny, it’s hard on the soul but easy on the flesh!!
   Let us now “ohm” in green unison of carbon death care bliss, ohm……..

2. Austrian School=robber-baron economics Says:
   November 3rd, 2009 at 2:02 pm

   From the above article:

   > “Yes, regulation is needed. Market regulation, that is. At every turn, the government and its accomplices in the financial industry–the politically-connected players–have undermined the free market’s ability to self-regulate.”

   This was precisely the kind of cartoonish, ideological dogma that was used to justify the repeal of the Glass-Steagall Act:

   – http://www.globalresearch.ca/i.....;aid=10588

   And what did the repeal of Glass-Steagall lead to?

   A quadrillion-dollar derivatives bubble, that’s what!

   – http://www.webofdebt.com/artic.....atives.php

   Austrian School propagandists know this, of course, which is why they almost never even mention the WORD “derivatives,” let alone acknowledge that primary role they played in causing the ever-worsening financial crisis.

   

   Steve Reply:
   November 3rd, 2009 at 3:07 pm

   Austrian School=robber-baron economics, that’s just ignorant. Tell me, when exactly in the last hundred years have we ever actually PRACTICED austrian economics in this country? And you may want to re-read above: “Ironically, Ron Paul, a champion of free markets and the leading proponent of true deregulation in Congress, voted against the repeal of Glass-Steagall. Paul recognized that Gramm-Leach-Bliley was not deregulation but re-regulation, removing regulations but leaving government subsidies and privileges intact.” In fact, did you read the article at all? The current Fed-run monetary system is to blame. Who cares about the derivatives bubble, which wouldn’t have formed with a real-money basis or lender of last resort, pops anyway if the government won’t run to their aid with free money for big business? They wouldn’t have made such risky investments in that case, knowing they themselves were responsible if it went wrong.

   

   Morrissey Reply:
   November 3rd, 2009 at 7:34 pm

   Well said Steve! So tired of these trolls who pretend to kow the works of Von Mises or Rothbard.

   

   Steve Reply:
   November 3rd, 2009 at 9:53 pm

   I don’t know near as much as I should, but I think I know the bare minimum in believing that almost everything the government touches turns to shite.

3. will Says:
   November 3rd, 2009 at 3:10 pm

   It is the Phantom investments—like derivatives–that jack the market.