Regulating Something Other than the Problem
Veronique De Rugy argues that deregulation was not the culprit in the current economic crisis:
The great villain in the deregulation myth is the Gramm-Leach-Bliley Act, signed into law by Bill Clinton in 1999, which repealed some restrictions of the Depression-era Glass-Steagall Act, namely those preventing bank holding companies from owning other kinds of financial firms. Critics charge that Gramm-Leach-Bliley broke down the walls between banks and other kinds of financial institutions, thereby allowing enormous systemic risk to percolate through the financial world. This critique is the keystone of the “blame deregulation” case, but it doesn’t hold up: While Gramm-Leach-Bliley did facilitate a number of mergers and the general consolidation of the financial-services industry, it did not eliminate restrictions on traditional depository banks’ securities activities. In any case, it was investment banks, such as Lehman Brothers, that were at the center of the crisis, and they would have been able to make the same bad investments if Gramm-Leach-Bliley had never been passed.
Another common claim, that credit-default swaps and other derivatives left unregulated by the Commodity Futures Modernization Act of 2000 were a cause of the financial crisis, doesn’t stand up to scrutiny, either. Research by Houman Shadab of the Mercatus Center has shown that this argument is undermined by its failure to distinguish between credit-default swaps, which are simply insurance against loan defaults, and the actual bad loans and mortgage-backed securities at the root of the crisis. Stricter regulation of credit-default swaps wasn’t going to make those subprime mortgages any less likely to go bad.
There is room to argue that stricter regulation might have prevented risky loans from permeating the economy so deeply. Such arguments, however, assume that regulators would have targeted the correct risks, when the evidence — indeed, the origin of the crisis — suggests that government officials would not have (and still would not) dampened the trends that needed dampening.
As conservatives have been arguing for quite some time, the implicit government backing of bad mortgage loans through Fannie Mae and Freddie Mac was the key ingredient encouraging the financial industry to treat such mortgages as too safe of an investment. De Rugy notes that Fannie and Freddie “guarantee[d] nearly $5 trillion in home loans with a mere $100 billion in net equity.” She also highlights decreases in capital ratios permitted by the regulators themselves.
I suppose there’s a case to be made that regulations that counteracted incentives that the government created with low interest and financial backing of bad mortgages would be to the good. But why not just stop creating those incentives by decreasing the role of government?