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.
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.
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.
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!
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?