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The current crisis and government regulation

December 17, 2008

My good friend Aaron Cruikshank posted to his blog today a note on the role of the free markets and government regulation in the current economic fiasco.  My post is in response to his (which can be seen at http://friuch.com/wordpress/when-the-going-gets-tough-leaders-point-fingers).

The seeds were sowed for this fiasco in 1938, reinforced in 1968, 1977, 1999 and again after 2000 by Greenspan’s low interest rate policy.  Yes, business people got drunk on the sub-prime and ABCP markets and I never excuse egregious business practices.  But the fact of the matter is that this crisis was created by government, reinforced by government and encouraged by government.  Those calling for more regulation are asking for more trouble…eventually.

1938

Fannie Mae was created in 1938 to “support the national commitment to housing” and, more importantly, to backstop “the inability or unwillingness of private lenders to ensure a reliable supply of mortgage credit throughout the country.”  Read: sub-prime loans.

1968 to 1970

In 1968 the US government converted Fannie Mae into a private shareholder owned company and in 1970 created what is now know Freddie Mac.  Freddie Mac’s purpose is to compete with Fannie Mae (yes, a government owned institution competing with a shareholder owned company) and specifically to purchase mortgages, package them up into securities and sell them.  The thinking was that if lenders knew they could sell mortgages onto Freddie Mac that this market would remain liquid. 

1977

Jimmy Carter created the Community Reinvestment Act (CRA) which was established to “encourage” private banks to end their “discriminatory” lending practices.  The CRA was created to ensure all Americans, regardless of their ability to repay loan obligations, were able to pursue the American dream of home ownership.  The CRA audited books of chartered banks and would consider a bank’s loans to sub-prime borrowers when authorizing additional branches or mergers and acquisitions.  

So you’re a bank that’s forced to lend to people who can’t afford mortgages.  But there are these convenient behemoths that will purchase these toxic obligations from you, thereby eliminating your exposure.  And if you don’t make these loans then you can’t add branches or merge with or acquire other banks.  Management has a responsibility to shareholders to grow their wealth, so what would they be forced to do in order to grow?  Adhere to the CRA.

1999

In his infinite wisdom, Bill Clinton exacerbated an already distorted lending environment by putting pressure on Fannie Mae to expand its loans to sup-prime borrowers.  I can’t find a reference, but my understanding is that his administration actually set minimum sub-prime quotas for Fannie and Freddie.  adding fuel to the fire!

Final thoughts

No doubt there was malfeasance in the private sector and I want to reiterate that I don’t obfuscate this commercial greed with pious business practices.  But I’ve read too much from too many periodicals and newspapers blaming the free markets.  Make no mistake about it, this recession was brought on by Democrat and Republican administrations dating as far as back FDR’s New Deal.  

It’s dumbfounding to me the fervent support governments are getting for the tremendous “investments” they are making in their economies.  My greatest fear is that, because Joe Q. Public is so afraid, governments around the world have been given a once in a lifetime opportunity to grow, grow, grow and to reach much deeper into our pockets.  

Governments drink their own kool-aid and really believe in their destinies as the solution to all society’s ills.  Giving them a blank cheque to bail us out of this mess will only perpetuate what was has been created by FDR and encouraged by Carter, Clinton, Bush and Greenspan.  

Isn’t it time to let the market purge the irresponsible players (it will be painful, I know) and let a sensible market take over?

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3 Responses to “The current crisis and government regulation”


  1. Dave, thanks for this posting. I read his piece and posted this response this comment.

    Very interesting read which was forwarded to me by Davidson Heath (link to http://www.davidsonheath.com/blog).

    I have long been a believer that:

    (1) Government’s role does not include participating in business.
    (2) Elected governments should be permitted to govern and not constantly have to worry about being defeated (like our minority parliament in Canada).
    (3) Checks and balances are good. Elected dictatorships are not.
    (4) Markets work (the current froth calling for more regulation in response to the US and world economic malaise is bizarre given that misguided and ever expanding US regulation dating back to 1938 and FDR’s New Deal (read my blog entry at http://preview.tinyurl.com/8zcd2r for more detail) is what cause the current mess.)

    Now as we find ourselves at the beginning of 2009 I find that I am both fearful and hopeful at the same time.

    I am fearful that governments around the world are using the current economic crisis as an excuse to expand their role in society. Voters are scared and I fear government is using that fear to its own advantage – using it to justify its growth.

    I am hopeful that current political leadership will pull back its now formidable reach into business (with the US stimulus Obama is really becoming “CEO in Chief” as FORTUNE magazine pointed out) after our economies recover. Naive, I know.


  2. […] see a previous post of mine (read it here) where I outline, from my perspective, the cause of our current malaise.  But that aside, […]


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