Dispelling The 'Deregulation' Myth

A dubious and dangerous idea seems to be gaining strength — that
government caused the financial crisis by giving capitalism free rein.
If anything, it hasn't done enough of that.

OK, we'll say it if no one else will: Thank heaven for Gramm-Leach-
Bliley. If you've been listening to the fulminations from Congress and
the campaign trail, you know that we're talking about the 1999 law
that dismantled the Depression-era barriers between commercial and
investment banking.

Democrats largely supported it at the time, and one of their own, Bill
Clinton, signed it. Now they frame it as a Republican bill that helped
send the nation on the path to perdition.

AFL-CIO President John Sweeney said it's time to roll it back: "The
system of regulation of these integrated banks has failed, and it is
clear that much stronger firewalls are needed." Majority Leader Harry
Reid — one of 90 senators who voted for the bill in its final version
— took off after its co-sponsor, Phil Gramm, who Reid said "was
responsible for deregulation in the financial services industries that
paved the way for much of this crisis to occur."

Maybe they know better, but they just can't resist kicking Gramm, who
was dumped from John McCain's campaign back in July after suggesting
that America had become "a nation of whiners." You don't scold voters
in an election year, and Democrats still seem to think they can score
points from Gramm's gaffe.

This is no way to start a serious policy debate. And to suggest that
the free-market principles embodied by Phil Gramm in his Senate career
are at the root of the current financial crisis is not only dubious,
but also dangerous. If people are convinced that capitalism is the
problem, they'll accept a regulatory regime that sharply pulls in its
reins, shifting power from business owners to union bosses such as
Sweeney.

So it's time for some fact-based discussion of Gramm-Leach-Bliley and
the whole policy trend called "deregulation."

First, that bill didn't make regulation go away. It modernized the
rules to fit the realities of the financial markets. Washington
doesn't always get the rules right, but in this case it did.

Also, Gramm-Leach-Bliley didn't take down the firewalls between
deposit-based banking and investments. Banks can't play the stock
market or trade credit default swaps with your savings account.
Investment and banking operations run under one corporate roof, but
otherwise stay separate.

So why did banks and investment houses get into so much trouble? It
will take a long and exhaustive post-mortem to answer that question
fully, but one point is already clear: They made mistakes that had
nothing to do with the 1999 law.

Commercial banks threw lending standards out the window in their rush
to get new business. Like S&Ls of the 1980s, they would have gone wild
without Gramm-Leach-Bliley. Washington, if anything, egged them on,
but not because of free-market dogma. Banks and mortgage brokers were
pumping up the homeownership numbers in America, and politicians were
eager to take credit for that.

[Who is to blame?]
http://cafehayek.typepad.com/hayek/2...-to-blame.html
http://www.ibdeditorials.com/IBDArti...06370789279709
http://www.townhall.com/columnists/T...upt_exploiters
http://www.townhall.com/columnists/T...oiters_part_ii

Wall Street, meanwhile, became a victim of its own innovation. It
created new classes of derivative investments that spread — and,
through leverage, amplified — the risk from the subprime mortgages
produced by the banks. A new multitrillion-dollar market emerged
almost overnight, lacking in transparency and reliable price signals.
With their asset values in doubt, investment banks lurched toward
insolvency.

If regulators failed here, it wasn't because of policies adopted years
before. It was more of the same story that has played itself out over
and over in modern finance: Innovation races ahead of the rules.
Crises tend to take almost everyone by surprise — including the major
players as well as the regulators.

Careful study in the aftermath can lead to smart policies that cushion
the blows of future shocks, but it doesn't prevent them entirely. Nor
should it. Capitalism needs some room for trial and error, bringing
out new ideas and testing them in adversity.

In this respect, Gramm-Leach-Bliley has turned out to be smart policy
indeed. By repealing the rule against banks owning investment firms,
it has led to at least two crucial mergers — JPMorgan Chase absorbing
Bear Stearns and Bank of America merging with Merrill Lynch. Morgan
Stanley may be the next investment house to find shelter in a well-
capitalized commercial bank.

You can spot the theme he By taking down an outmoded firewall, the
law is helping the financial industry cope with a once-in-a-lifetime
crisis. Far from being the cause, this instance of deregulation, or
whatever you call it, is part of the cure.

http://www.ibdeditorials.com/IBDArti...06716557967194