Built on Facts

Lack of Regulation, and the Crisis

Mean-spirited reactionary politics below the fold. If you’re a kind-hearted liberal here for the physics, you might want to skip this post, have a nice tea instead, and calmly meditate on Obama’s recent rise in the polls.

I’ve had several conversations with people over the past few days about the cause of the current financial crisis. One common refrain is that deregulation regulation pushed though by heartless free marketers is the cause. “Ok”, I ask them, “what regulation specifically?” And I generally don’t get an answer. The reason is that the crisis is due to loans not being repaid. The only way to have prevented that would be to have prevented the loans from being made. The only way to do that would have been to deny credit to low-income people and people with bad credit. One party was opposed to any such regulatory regime which would have had the effect of making credit harder to come by for poor, often minority borrowers. I don’t think the NYT is generally accused of bias in my direction, so we’ll use their and the Los Angeles Times’ news reports.

New York Times, 1999.

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

Los Angeles Times, 1999

In 1992, Congress mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains. It has aimed extensive advertising campaigns at minorities that explain how to buy a home and opened three dozen local offices to encourage lenders to serve these markets. Most importantly, Fannie Mae has agreed to buy more loans with very low down payments-or with mortgage payments that represent an unusually high percentage of a buyer’s income. That’s made banks willing to lend to lower-income families they once might have rejected.

New York Times, 2003

“The regulator has not only been outmanned, it has been outlobbied,” said Representative Richard H. Baker, the Louisiana Republican who has proposed legislation similar to the administration proposal and who leads a subcommittee that oversees the companies. “Being underfunded does not explain how a glowing report of Freddie’s operations was released only hours before the managerial upheaval that followed. This is not world-class regulatory work.”

Significant details must still be worked out before Congress can approve a bill. Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing

“These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

Representative Melvin L. Watt, Democrat of North Carolina, agreed.

“I don’t see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing,” Mr. Watt said.

Cutely enough, the bill that has been occasionally scapegoated for causing this crisis passed the senate 90-8 in a strongly bipartisan manner. Biden voted yea. McCain didn’t vote. Now all this isn’t to say the Republicans are blameless – they were in power in congress since 1994 and in the presidency since 2000. They could have reigned in Fanny and Freddy, but they didn’t. What I am saying is of the specific policies implemented by congress which helped cause this, deregulation isn’t one of them. Naive congressional idealism about mean old bankers denying credit to Tiny Tim is.

Don’t think for a moment that I’m criticizing the loaning of money to low-income people or minorities. It’s a great thing for everyone to have fair access to credit. But bending the rules and lowering standards is not that, and once it became common practice this current crisis was inevitable.

That is the cold, hard history. My interpretation of that history is my own, but I think at this point blaming deregulation while knowing the above is simple demagoguery.


  1. #1 AnonymousCoward
    September 26, 2008

    If that is indeed the case, how is it possible for the problem to tremendously outweigh the entire mortgage market? Or is it more likely that the mortgage notes were just cogs in the infernal machine?

    Hint: Derivatives, rate cuts, and deregulation oh my.

  2. #2 anon
    September 26, 2008

    The Investor’s Business Daily has a good piece here:


  3. #3 Josh
    September 26, 2008

    The NYT is consistently lambasted (right or wrong) for being a liberal newspaper.

    This is a problem of regulation, not just one of lending to poor people who couldn’t afford their houses. Lenders were making loans to people without ANY due diligence. At one point, loans were being made to people without verifying their income or even performing a credit check. Regulation specifying basic fact checking requirements for mortgages would have made a difference.

  4. #4 Todd
    September 26, 2008

    As far as CRA goes, this article suggests you may be barking up the wrong tree. Giving loans to people who can’t pay them is generally a bad idea, but CRA banks didn’t give out liar loans, NINJAs, or wacky interest only ARMs.

  5. #5 Left_Wing_Fox
    September 26, 2008

    I agree with you, but here’s a longer set laying out a number of other regulations by name that contributed:


    The problem is that these sort of bubbles and jumps are the natural result of a deregulation, as safeguards are eliminated, risky behavior can rack up exciting short term gains for severe mid-term risks. Everyone is so blinded by the exciting short term rise that they excuse away or rationalize the risky behavior to participate in it.

  6. #6 Sparky Clarkson
    September 26, 2008

    The problem is not that so many people got loans that they couldn’t afford, not even close. The problem is not even that so many people ended up defaulting on their loans (thank you new bankruptcy laws). The problem is that these packages of subprime mortgages made to low-income families were treated as if they were high-grade mortgages made to high-income families. Had the risk information been accurately forwarded through every level we could have avoided this mess even if Fannie and Freddie handed out ARMs to every bum in New York. Accurate risk assessment was stymied at every level, however… Dishonest applicants lied about their income. Mortgage brokers took a “Don’t ask, don’t tell” approach to lenders’ financial situations. Bond raters took a holiday. Investment bankers skipped their due diligence. Nobody called anybody on any of it.

    I can’t say off the top of my head whether the problem was DEregulation or NONregulation, but the bottom line is that risks were not accurately reported, and neither the regulations nor the enforcement existed to ensure that they were.

  7. #7 Mark
    September 26, 2008

    It wasn’t just mortgage defaults that led to the current crisis; otherwise, the huge investment banks and insurance companies wouldn’t have been affected. The unregulated trading of securities based on these subprime mortgages allowed the buildup of debt amongst the large investment firms. To me, it seems like a new kind of hedge fund in which too many institutions took part.

    Perhaps Congressional encouragement created the need for a way to manage the risk of subprime borrowers, but the deregulated nature of this new kind of trading resulted in the current market panic since no one knows which companies bought how many of these securities.

  8. #8 Moopheus
    September 26, 2008

    “subprime” doesn’t necessarily mean poor. It means poor credit. And pretty much by definition, you should be cautious loaning money to people with poor credit. In the 90s, the Fed was given some authority to regulate non-bank mortgage lenders. It could have restricted no-doc lending; it chose not to. It could have enforced stricter underwriting standards; it chose not to. It could have restricted risk-layering of loans; it chose not to. Outright fraud was rampant at all phases of the process; the government turned a blind eye to it. Doing these things would not have restricted credit to the credit-worthy, or even to the people who just “needed a break.” It wouldn’t have stopped the bubble, either, but would have tempered the excesses.

  9. #9 Alastor
    September 26, 2008

    Matt, your assessment of the cause of the mortgage crisis is overly simple. Government-supported lending to low-income borrowers is one factor in a complicated picture, as is weak oversight creating a moral hazard in the mortgage chain. The wikipedia article on this provides a good overview I think.


  10. #10 Russell
    September 26, 2008

    At least Mike Dunford put some numbers to his explanation of why the CRA is not a culprit:


  11. #11 Davis
    September 26, 2008

    Mark over at Good Math, Bad Math discusses the role derivatives and leveraging played in turning this into a large-scale mess. Judging from his discussion, lack of regulation (I don’t know offhand if it was deregulation or not) was certainly part of the problem there.

  12. #12 Zifnab
    September 26, 2008

    :-p Long story short, on this one you’re totally wrong.

  13. #13 Carl Brannen
    September 26, 2008

    The CRA, along with regulatory changes over the years, lowered the bar in bad neighborhoods for loans. It’s not the case that ALL the loans in those neighborhoods were by banks through CRA, what is the case is that the CRA caused all providers of mortgages, bank or not, to let people buy houses cheap.

    As far as where the problem is now, this would be going on still except for one thing, an increase in foreclosures. And where are the foreclosures? No, the rich are not getting foreclosed. The middle class has had homes for years and have built up equity. (There are exceptions and this makes for great TV so you it is easy to get the impression that rich people are getting foreclosed.)

    Instead, the foreclosures are in the bad neighborhoods, right where the banks would have expected them. Would the banks have loaned money there without government intervention? All you need to do to answer that question is read what the Democrats used to justify the laws that caused these problems. Do a google for “foreclosure” + “inner city”.

    Now, the Democrat’s solution to the problem is to let the government own the mortgages. Soon enough they will want the borrowers to get their homes for free. That is how democracies work, political parties channel money to their constituencies.

  14. #14 Zifnab
    September 26, 2008

    Several years ago, state attorneys general and others involved in consumer protection began to notice a marked increase in a range of predatory lending practices by mortgage lenders. Some were misrepresenting the terms of loans, making loans without regard to consumers’ ability to repay, making loans with deceptive ‘teaser’ rates that later ballooned astronomically, packing loans with undisclosed charges and fees, or even paying illegal kickbacks. These and other practices, we noticed, were having a devastating effect on home buyers. In addition, the widespread nature of these practices, if left unchecked, threatened our financial markets.

    Even though predatory lending was becoming a national problem, the Bush administration looked the other way and did nothing to protect American homeowners. In fact, the government chose instead to align itself with the banks that were victimizing consumers.


    Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.

    Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.

    In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government’s actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.


    When history tells the story of the subprime lending crisis and recounts its devastating effects on the lives of so many innocent homeowners, the Bush administration will not be judged favorably. The tale is still unfolding, but when the dust settles, it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers.


  15. #15 Uncle Al
    September 26, 2008

    Here’s the menu,

    0) Do nothing. Let the dead parts fall off absent management to screw up the process and disappear a cut of the cashflow as performance bonuses.
    1) The US remonetarizes. The dollar and all debts associated with it are declared void.
    2) The US defaults on its debts.
    3) Brutal taxation and outright confiscation of private wealth (post WWI and WWII).
    4) Brutal inflation to make dollar amounts worthless as buying power (post-Vietnam)
    5) Literally sell off parts of the nation (Louisiana Purchase re France, Alaska re Russia)
    6) Washington flees to Paraguay, the wealthy and corporate run overseas. The US burns; bottom line 100-200 million dead.

    Vote for McCain and Moose Jewel! Let’s get it over with.

  16. #16 steve
    September 26, 2008

    either way there are a lot more than just 1 cause and undoubtedly every vote in congress on regulation and dereg caused this to happen. Both seem to be the culprit

  17. #17 Bill
    September 26, 2008

    A quick Google search “site:whitehouse.gov ‘home ownership'” gives about 60 pages worth of the current administration talking about all the wonderful things that they did to reach a record high home ownership rate. Obviously there were good reasons for many of these people not to own homes that they could not afford. Good press and good policy are not always the same, and there is no shortage of blame to go around.
    The crisis itself is largely due to unregulated securities, and the ridiculous 30:1 leverage allowed to investment banks (so a 4% swing would literally wipe them out). The mortgage/CDO/CDS/Derivatives may have caused the swing in market value, but a 5% swing should not be enough to destroy a firms entire value.

  18. #18 Matt Springer
    September 26, 2008

    Bill & Zinfab, I’m not trying to exonerate Republicans in general or GWB in particular. I say so in the post. What I am saying is that while there’s plenty of blame to go around, blaming deregulation as a policy is barking up the wrong tree.

    Alastor’s comment that “Government-supported lending to low-income borrowers is one factor in a complicated picture, as is weak oversight creating a moral hazard in the mortgage chain.” is on the right track. There is a moral hazard, and it’s in passing a $700b bailout bill that tells every company that if you can be irresponsible enough en masse, the taxpayer will be made to bail you out. That’s unacceptable. Let them fail.

    It won’t be fun, but it won’t be any kind of Armageddon either. The FDIC protects depositors, and liquidity will continue to be available from local banks which already provide a huge part of the market for loans without engaging in these shoddy securities practices.

  19. #19 Carl Brannen
    September 26, 2008

    The history of the US economy since around 1985 has been a series of “rolling recessions”. That is, the recessions hit some specific subsector of the economy.

    I didn’t see the mortgage banker giving a tinker’s dam when the farmers were getting killed by the high value of the US dollar. I don’t see why the farmers should bail them out of the huge mistakes they made when the farmers never made any huge mistakes.

    Right now, all the US export industries are looking at doing very good business over the next few years. Things are not so bad.

  20. #20 Karen
    September 26, 2008

    Does anyone know what percentage of homeowners truly OWN (i.e. have paid off all loans) on their homes?

  21. #21 CCPhysicist
    September 26, 2008

    Thanks, Matt, for telling me that you (like McCain) think it would be a good idea for a financially solvent insurance company that holds a significant part of my retirement money (having been endorsed as a safe place for that money by my state and yours) to go bankrupt, affecting my access to those funds even if that sub-company remains solvent and secure. That you think some poor widow should have to go through a bankruptcy court to get payment on her husband’s life insurance policy. You are wrong.

    You need to listen to the small businessman who celebrated the demise of the rich speculators in 1929 only to lose his business and everything else in 1930 … and realized he was as wrong then as the anti-regulators had been in 1920.

    This problem started when banks were allowed to be something other than banks. When the laws written after the Great Depression were repealed. Spin history any way you want, but they were repealed by McCain-style free-market Republicans. The problem is not sub-prime loans. It was selling CDOs containing only sub-prime loans as if they were AAA-rated prime loans. It was criminals selling property and loans together and lying about the terms of the loan, based on a business model where you profit from closing the loan and profit again when you foreclose on it, and then packing those lies into a “security” which was then sold by a bank as if it were gold.

    The S-and-L crisis (which might have been before you were born, but remains relevant today) was a result of lax regulation and was fixed only by government financial intervention and re-regulation while making sure the owners paid a big price.

    What you also need to realize is something I learned today from a story on CNBC. There is 1300 trillion (that is not a mis-print, 1.3 peta dollars) of *derivatives* in the market. To update Sen. Everett Dirksen, a trillion here or there and pretty soon we are talking about real money. Imagine if an angry guy decided to settle a score with Wall Street and the problem got 1800 times bigger than the 0.7 trillion you think is a big deal!

    My parents grew up in that environment. You don’t want to revisit that world. It was not friendly to PhD physicists.

  22. #22 Jane
    September 27, 2008

    I agree that loans were made to people who couldn’t afford them — but there is a second part to that problem that seems to be grossly ignored. The average price of a new home is approximately $260,000; the median salary of an individual over 25 is approximately $32,000.

    I know it’s a wild idea, but why can’t a plan for affordable housing also be brought into the equation? Gosh, if people were able to have a better chance at buying a house they could actually afford, what would become of this country? I bet for one, we would have had less of a mortgage lending scandal.

  23. #23 Matt Springer
    September 27, 2008

    CC, I’m pretty sure that 1.3e15 dollar figure is an economic fiction that depends heavily on how money is defined. The combined GDP of the entire planet is only in the 6e13 dollar range.

    I was alive during the S&L crisis, though I’m too young to have remembered it. But we survived that, and the bailout even inflation adjusted wasn’t this big. In fact I wouldn’t be shocked if the moral hazard from that bailout helped create this mess. I also remember well the collapse of the dotcom boom coupled to 9/11, which erased 5 trillion dollars of wealth in two years. We survived that too and recovered quickly. We will easily survive this, and neither your retirement nor my employment prospects are suddenly going to vanish because of failure of some large banks, any more they they did during any of the other ‘crises’.

  24. #24 Carl Brannen
    September 27, 2008

    Insurance companies, like banks, do not go to bankruptcy court. Insurance companies get taken over by the state regulators and run by them. Look for recent introductory article titled “When an insurance company fails” by Melissa Gannon to learn more.

    And the vast majority of derivatives are not in trouble so the size of the industry is not an indication of a general financial meltdown.

    The really bad 1/3 of the sub prime mortgage paper was mostly held by the companies that created them as they were below junk bond status. The relatively high foreclosure rate killed that paper off.

    The next 1/3 were sold as junk paper. I wouldn’t think insurance companies would be putting widow’s money in that. And the highest 1/3 is still paying off, and will very likely remain paying off. It’s just that the resale market for them has dropped (also known as interest rates have risen). For an insurance company that’s no big deal. They don’t deal in these things, they buy them and hold them. For a business which needs to be able to sell them in a hurry (for instance because they are deeply leveraged) the lack of liquidity is bankruptcy as soon as they have (the equivalent of) a run on the bank.

    When an insurance company is taken over, most policy holders don’t notice any difference. Widows are still paid. Sometimes the regulators reduce payoffs by a percentage. And the regulators turn off the “surrender” option that whole life includes. “Surrendering” means cashing out your policy early, NOT collecting on it when your bread winner dies. This is how the regulators stop the “run on the bank” problem.

    As long as we’re on this subject, my bet is that whoever ends up buying the subprime mortgage paper will be able to make a nice profit on it. That would be the US government in this bailout except that they are complete goofballs and squirt wasted money out of every pore. Most of this is because of the requirement of “fairness”. This makes for extreme inefficiency. Due process is expensive. Government could lose money selling golden eggs from a magic duck.

    From a political point of view, it makes perfect sense to yell fire in a crowded theater (when the other political party is likely to be the worse trampled by the unnecessary rush for the exits). Not doing this sort of BS is the essence of McCain’s promise to hold America first, before party, and that is one of several reasons why I’m voting for him.

  25. #25 Anonymous
    September 27, 2008

    Just a note — the 90-8 vote you cite three paragraphs from the end wasn’t to pass Gramm-Leach-Bliley, but a vote to agree to a conference report. The act itself passed 54-44 (and, yes, a certain McCain and Biden voted aye and nay, respectively).

  26. #26 Oldfart
    September 27, 2008

    Not doing this sort of BS is the essence of McCain’s promise to hold America first, before party, and that is one of several reasons why I’m voting for him.

    What a load of crap. McCain holds McCain’s need for power before party, country, family, anything else in the world. His recent behavior is that of a doddering old man scared that he will miss is last piece of ass. Whatever honor McCain ever had is long used up and conspicuously missing in this campaign and is the reason I will NOT be voting for him.

  27. #27 PM
    September 27, 2008

    Humility, humility. Was it not PhD Physicists who wrote the overall risk assessments, the derivatives, etc., in the big banks? Friends and friends of friends. Smart, too. They thought about how to understand and manipulate risk for years. State transitions, however, are not beasts that are easily understood or tamed by the simple-system tools of differential equations and time-series analysis. Not a Hamiltonian system of a few degrees of freedom.

  28. #28 Russell
    September 27, 2008

    The creation of MBOs and derivatives from mortgages has been a huge win for the individuals and companies who did it. The quants to whom PM refers, and their colleagues and bosses, and the companies for whom they worked, are not going to return the hundreds of billions of dollars they made doing that. They get to keep that money. They are long out of the loop, and suffer no ill from the crisis. The same is true for the sales people who originated all those negative equity, negative amortization, no job check mortgages.

    Those people didn’t fail economically. They succeeded. Many have retired on the millions they made. Given the same circumstances and the same incentives, the same thing will happen. That is the moral hazard that went into creating this crisis.

    The big problem with blaming the CRA — besides the ugly scapegoating — is that doing so hides the real problem: that at each step along the way in creating the industry of financial instruments tied to mortgages, the real risk of the base transaction became more abstract and easier to minimize. The natural incentives then led to a systemic failure that created much more paper value than there was real value.

    Let me be clear that I am not blaming the quants or traders or even the sales folks who originated the flaky mortgages. People work for their salary and commissions and bonuses. Systemic failures need systemic solutions.

  29. #29 Matt Springer
    September 27, 2008

    #25, the conference report is an agreement between the House and Senate about reconciling the two versions of the bill and its amendments. The bill dies unless this is done, and if it is done it’s the vote that actually sends the bill to the President’s desk (in this case Bill Clinton’s) for signing or veto.

  30. #30 KevinL
    September 27, 2008

    It’s interesting to see the wealth of links to explanations and analysis in response to this post – a much more rational response than most places 😉 My post, I’m afraid, is all opinion.

    In terms of what caused what, it appears fair to say that while the $150b or so of potentially bad mortgages has triggered the situation, the situation wouldn’t exist at all without the extra markets and speculation created due to lack of regulation and oversight – that is, the defaults at the bottom are closer to being a catalyst than a reason. If you took them away, the bubble created by lack of regulation would still be growing, and the risks would be getting larger and larger.

    On the other hand, if you put the regulation and oversight back in, and ensured that business weren’t able to trade themselves to as high a position of risk as they have (at least, not without people being able to measure that level of risk and change their investments in those companies accordingly), the defaults on mortgages wouldn’t cause this sort of problem.

    In addition, it seems like the lack of measurability – the fact that a lot of the default credit swap market was non-transparent – forces the market (in the form of investment and insurance decisions) to be making non-informed choices – which inevitably leads to badness. Govt regulation should be about ensuring that the people who buy shares in companies are able to make decisions based on as much and as true information as possible – otherwise, “the market” can’t function properly, and you get what you’re seeing now – a sudden correction as people realise that what they thought was a sound investment, isn’t.


  31. #31 Bill
    September 27, 2008

    Just another link to add to the discussion from the NY Times:

  32. #32 Matt Springer
    September 28, 2008

    Several people have commented on the lack of transparency in these securities trades that have gone south. This I agree with. I don’t really care how financial institutions want to make deals with each other – in a free country that should be given very free reign. And as above I don’t think it’s very defensible to say that lack of regulation was the root cause. But I do care that the people investing in those institutions be able to know what’s going on. If disclosure and transparency counts as regulation, then in that case I to think poor disclosure rules share some blame and I’d very much like to see stronger regulation in that regard.

  33. #33 razib
    September 28, 2008

    scienceblogs shouldn’t give you a platform to spout your reactionary diatribes! this post would make friedrich von hayek proud!

  34. #34 Russell
    September 28, 2008

    These two statements are contradictory:

    1) “I don’t really care how financial institutions want to make deals with each other.”

    2) “But I do care that the people investing in those institutions be able to know what’s going on.”

    Financial institutions regard some of what they do as proprietary. They release some information, but not all. The pure libertarian view is that investors can buy a pig in a poke if they want, and that the market would then determine the “right” amount of transparency. Systemic failures will happen, but so what? Depressions are short in Libertopia.

    “If disclosure and transparency counts as regulation..

    Requiring disclosure and transparency has always counted as regulation. E.g., Sarbanes-Oxley. Accurate disclosure requires processes, and carries both direct and indirect costs.

    A lot of money was made slicing and dicing mortgage securities. Regulation of the sort you’re proposing would have hampered that. Which at the time, would cause the companies doing so to scream about over-regulation. They were doing what ambitious people do in the presence of incentives. It turns out, in retrospect, that a lot of the paper value they created was entirely artificial. And now we’re living with the consequence of that.

  35. #35 Matt Springer
    September 28, 2008

    Well, I’m not a pure libertarian or even really a libertarian at all. I just have some libertarian-ish views.

    The issue is not just the proprietary nature of some financial dealings. Those aren’t so bad, and in fact large sections of finance and industry would be impossible if trade secrets could not be protected. The issue is the dishonesty of those dealings in pretending that bundled sub-prime loans were just as good as other much safer and secured financial instruments. They weren’t, and they knew it. While some libertarians would defend the right of a business to lie about their product, I’m not one of them. It’s just simple truth in advertising, which as far as regulations go is pretty universally accepted.

    On the other hand it’s easily possible to take that kind of argument and go overboard. Sarbanes-Oxley is widely considered to be a genuine debacle, with tremendous cost for negligible benefit.

    So are depressions short in Libertopia? Beats me. I think they might, but experimental tests are in short supply.

  36. #36 Paul Murray
    September 28, 2008

    “The only way to have prevented that would be to have prevented the loans from being made. The only way to do that would have been to deny credit to low-income people and people with bad credit.”

    No. The loans in question – trillions of dollars worth – are not mortgages, but loans that financial institutions made to each other backed by mortgages as colateral. It is these loans that should have been prohibited.

    In any case – of *course* loans should have been denied to low-income people. Where on earth did you get the idea that every person deserves a free-standing dwelling, and that society should be structured so as to provide one? America (and no nation) can afford to build a white-picket-fence slice of suburbia for each of its inhabitants. Costs too much. And it’s a waste of productive capacity.

  37. #37 Matt Springer
    September 29, 2008

    Mortgages or mortgage-backed securities. Six of one, half-dozen of the other. Neither would be in trouble were the mortgage payments made on time.

    And heck, I’ll see your right-to-loans and raise you. The government ought to send every family a ten million dollar check. The we’d all have lovely houses, abundant healthcare, unlimited education, no debt, and all the carbon offsets we could ever need.

  38. #38 CCPhysicist
    September 29, 2008

    Carl – That is correct about the insurance companies eventually being taken over by the respective states, but if that were to happen inside an international bankruptcy, even that process would be affected by necessary legal actions. State regulators were very worried about that, just as policy holders might not get their money in a timely fashion if they have to go through their individual State system for handling failed insurance companies.

    Of course, today the markets spoke: down 7% for the DOW (9% for the wider market) because the House voted down the plan. Should all retirement plans pull their money out of equities and into cash tomorrow, driving the market down by 1929 factors? That would be a real concern.

  39. #39 randy
    October 1, 2008

    i’m here about a week too late, but you’re wrong that “the reason is that the crisis is due to loans not being repaid”.

    the real reason for this crisis is widespread fraud. lenders, appraisers, banks which packaged and resold the home loans, borrowers, they all lied and lied and lied.

    the biggest liars were the ones at the very top of the food-chain, the ginormous banks. consider that wachovia was worth $75 billion on paper, then citi stepped in and bought them for a mere $2 billion. ummmmmm…how is that even possible without 30-years-in-prison type fraud?

  40. #40 vimothy
    October 6, 2008

    I don’t know if anyone in the comments has actually pointed out some of the specifics, but just in case they haven’t:

    Gramm-Leach-Bliley Act repealing Glass-Steagall, 1999;
    Gramm’s Commodity Futures Modernization Act, 2000 (legitimating credit default swaps);
    The decision of the SEC in 2004 to allow the big lnvestment banks to increase their leverage;
    The Depository Institutions Deregulation and Monetary Control Act, 1980 (removed ceilings on mortgage loans so created the subprime market);


    I say this is as a classical liberal. It gives me no pleasure. And probably most of these were done with the best of intentions. However, certain acts of deregulation certainly had a part to play in the crisis currently unfolding.

  41. #41 vimothy
    October 6, 2008

    Mark Thoma says it well:

    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).


  42. #42 Matt Springer
    October 6, 2008

    I’ve noticed that a large number of European banks are now in trouble, and they weren’t part of the US regulatory regime at all. Of course, they weren’t selling loans as part of the CRA either. You could argue that it was sketchy US financial instruments that got them in trouble in the first place, but then why would their regulatory agencies have allowed them to purchase such securities at all? After all, they weren’t deregulated any time in the recent past of which I’m aware.

    I’m beginning to think this is a more systemic problem than just something specific to the banking system.

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