Two wildly divergent points of view here.
The first comes from a lengthy piece in the New York Times about uber-deregulator Phil Graham. It’s hard to listen to him and think that we’re living on the same planet . . .
He blamed others for the crisis: Democrats who dropped barriers to borrowing in order to promote homeownership; what he once termed “predatory borrowers” who took out mortgages they could not afford; banks that took on too much risk; and large financial institutions that did not set aside enough capital to cover their bad bets.
But looser regulation played virtually no role, he argued, saying that is simply an emerging myth.
“There is this idea afloat that if you had more regulation you would have fewer mistakes,” he said. “I don’t see any evidence in our history or anybody else’s to substantiate it.” He added, “The markets have worked better than you might have thought.”
The “act” he’s most famous for is Graham-Leach . . .
In late 1999, Mr. Gramm played a central role in what would be the most significant financial services legislation since the Depression. The Gramm-Leach-Bliley Act, as the measure was called, removed barriers between commercial and investment banks that had been instituted to reduce the risk of economic catastrophes. Long sought by the industry, the law would let commercial banks, securities firms and insurers become financial supermarkets offering an array of services.
The measure, which Mr. Gramm helped write and move through the Senate, also split up oversight of conglomerates among government agencies. The Securities and Exchange Commission, for example, would oversee the brokerage arm of a company. Bank regulators would supervise its banking operation. State insurance commissioners would examine the insurance business. But no single agency would have authority over the entire company.
“There was no attention given to how these regulators would interact with one another,” said Professor Cox of Duke. “Nobody was looking at the holes of the regulatory structure.”
The arrangement was a compromise required to get the law adopted. When the law was signed in November 1999, he proudly declared it “a deregulatory bill,” and added, “We have learned government is not the answer.”
Not the answer. Huh.
It’s tempting to dismiss Elliot Spitzer for any number of reasons, which is too bad because he’s a smart guy who had a ringside seat to a lot of the financial services doings of the last decade. His piece in today’s WashPost is worth reading. A couple of clips.
On “de-regulation” and “free markets” . . .
The reality is that unregulated competition drives corporate behavior and risk-taking to unacceptable levels. This is simply one of the ways in which some market participants try to gain a competitive advantage. As one lawyer for a company charged with malfeasance stated in a meeting in my office (amazingly, this was intended as a winning defense): “You’re right about our behavior, but we’re not as bad as our competitors.”
No major market problem has been resolved through self-regulation, because individual competitive behavior doesn’t concern itself with the larger market. Individual actors care only about performing better than the next guy, doing whatever is permitted — or will go undetected. Look at the major bubbles and market crises. Long-Term Capital Management, Enron, the subprime lending scandals: All are classic demonstrations of the bitter reality that greed, not self-discipline, rules where unfettered behavior is allowed.
Those who truly understand economics, as did Adam Smith, do not preach an absence of government participation. A market doesn’t exist in a vacuum. Rather, a market is a product of laws, rules and enforcement. It needs transparency, capital requirements and fidelity to fiduciary duty. The alternative, as we are seeing, is anarchy.
One of the great advantages U.S. capital markets have enjoyed over the decades has been the view — held worldwide — that there was an underlying integrity to the representations market participants made, because the regulatory framework in which they were made was believed to provide genuine oversight. But as we all know, the laws requiring such integrity are meaningless without a government dedicated to enforcing them.
His prescription for going forward . . .
Three overarching priorities should guide government actions in the new structure. First, we need better control of systemic risk. The currently splintered federal regulatory authority, the continued presence of off-balance-sheet transactions for financial entities (even post-Enron) and the failure to subject major players to any government oversight means that nobody can really understand the full risk facing the financial system.
Second, investors must be protected with adequate, accurate information. Firms must offer transparency both to individual investors and to government regulators.
And third, as Eric R. Dinallo, the superintendent of the New York State Insurance Department, has wisely pointed out, we will have to step back from the current environment in which government has become a guarantor of all major risk. The so-called moral hazard will serve to devalue risk in the market, and this too will have a debilitating long-term effect on capital flows. Only if private actors have to bear the real risks they incur will the market function properly. We are now perilously close to nationalizing risk.
Both articles are worth reading. In case it matters and is not otherwise clear, I agree with Spitzer and think Graham is dangerous.
Tags: PhilGraham, Elliot Spitzer, Financial Meltdown, De-Regulation, Graham-Leach
