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Monday, October 06, 2008

Should Deregulation be Blamed?

Sebastion Mallaby says deregulation is not the cause of the financial crisis. Jamie Galbraith would disagree (more direct disagreement here and here):

Goodbye, Conservatives. Hello, Predators, by James K. Galbraith: Back in the Reagan days, Republicans talked economics. We had problems; they had solutions. Tight money would cure inflation. Low taxes would stimulate saving and hard work. Small government would "crowd in" investment; free trade would make us efficient. Smart people believed this, and they had Milton Friedman to back them up. I never thought they were right-but they were serious. They were coherent. And they argued with passion and conviction, which commanded respect.

But now, real economic conservatives have disappeared from the Republican stage. ... Bush is a bread-and-circuses reactionary with a clientele of lobbies. McCain gets his economic ideas from Phil Gramm, the ultimate architect of the Enron culture, of libertine speculation and financial disaster. ... This crowd deregulates and privatizes not because they think it might work out for the public... What they care about is putting their friends in charge.

Under Bush, oil and gas, drug companies and defense contractors, insurers and usurers, banks and big media control the government of the United States. John McCain..., as chair of the Senate commerce committee,... presided over Lobby Central; notoriously, his campaign is run by lobbyists ... and until last week his policy could be summed up in slogans: he was a "free market" man, a "deregulator." ... Bush and McCain are the predator state writ large...

On the morning that Lehman Bros. and Merrill Lynch fell,... the ... Dow Jones average fell 504 points... As stocks crashed, suddenly people remembered that modern markets cannot exist without a cop on the beat. Every important market out there, from fresh food and safe drugs to autos and air travel to housing and health care, depends on government to maintain trust, and without it, none of them would survive. Without regulation, predators take over, and when they do, trust eventually collapses. Every important market is in peril now, precisely because of the predators in power these past eight years. And none more immediately than finance.

The Bush-Paulson bailout exposed the predator state in detail. Deregulation and desupervision were the origin of this crisis: the 1999 Gramm-Leach-Bliley Act repealing Glass-Steagall, and the Gramm-authored loophole legitimating credit default swaps in 2000. Bush's financial regulators brought chainsaws to press conferences, a clear signal to sub-prime hustlers that "anything goes." "Liar's loans," "neutron loans" and "toxic waste" became financial terms of art. ...

It seems unlikely that John McCain, the regulation-wrecker, will become, overnight, the man who would turn vice to virtue on Wall Street. But even suppose he were serious. Who would trust him? No one with money on the line.

This is McCain's deeper problem. If he is elected, under his leadership, trust cannot be restored. ... Restoring trust requires a government of trustworthy people. Team McCain doesn't have any, and some, especially Gramm, inspire the opposite. It wouldn't matter what their policies were or pretended to be. Nothing they attempted would work.

The ... choice in this election is well-defined. One party believes that the government serves no public purpose. The other believes that it must. One party has turned the government over to lobbies, to cronies and to big donors. The other is beginning to realize that a real government must be rebuilt. One party would keep the same crowd in office; the other would have to begin by clearing them out. No one can say there is no difference between the parties this year, and the basic issue in this election is really just as simple as that.

I thought the best part of Sebastian Mallaby's article came when he provided this link: "There's a vigorous argument about whether Calomiris's number is too high." As to his main argument, "that deregulation is the wrong scapegoat," I don't think it was deregulation of any particular sector that caused the problems we are having in credit markets, I think it was lack of effective regulation of the shadow banking sector in general (i.e. the regulations that did exist in the shadow banking sector were not directed at the right issues, thus, it's possible to believe, as I do, that some of the deregulation was warranted while still believing that needed regulation was missing). The shadow banking sector should be under the same regulatory umbrella that traditional banks are subject to, and extended the same sorts or privileges within the Federal Reserve system in return (deposit insurance of some type, and lender of last resort functions in return for regulatory restrictions). There is no guarantee this would have stopped the credit crisis from developing, but I don't think the conclusion we should draw from the present experience is that these markets weren't free enough. Hopefully, we can use what we've learned as the crisis has unfolded and also use what we've learned from regulating the traditional banking sector to devise a regulatory structure that will improve the stability of credit markets.

    Posted by on Monday, October 6, 2008 at 12:24 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (48)


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