Friday, September 26, 2008

Bill Clinton is Right about Glass-Steagall

Recently, a lot of Democrats and left-leaning journalists have been blaming the 1999 repeal of the Glass-Steagall Act for today's financial problems. I believe they are wrong. Their reasoning is based on the post hoc ergo propter hoc ("after the fact, therefore because of the fact") fallacy. They reason that since Glass-Steagall was repealed in 1999 and we have a credit crisis today, the repeal of Glass-Steagall caused the credit crisis.

The truth is that there were far more bank failures a decade prior to the the repeal of the Glass-Steagall Act than there are today, even though today's financial crisis is much worse.

Instead, today's financial crisis is due to the decline of a housing bubble. The housing bubble was caused by unreasonably low Fed interest rates, a savings glut overseas, and the get-rich-quick mentality of home buyers.

While many Democrats and journalists are wrong about the repeal of Glass-Steagall, Bill Clinton is right:
One policy Clinton said he doesn't regret is his repeal of the Glass-Steagall Act in 1999, which, for the first time since the Depression, allowed commercial banks to engage in investment banking activities. Clinton said the commercial banks were an important moderating force on the risk-taking of the big investment firms that collapsed this week. "In the case of the current crisis, I believe the bill I signed allowed Bank of America to take over Merrill Lynch," he said.
If Glass-Steagall were still law, a troubled Bear Stearns would not have been allowed to merge with JPMorgan. Also, Goldman Sachs and Morgan Stanley would not have been allowed to become commercial bank holding companies. The repeal of Glass-Steagall has been a savior, not a villain.


  1. There are less failures because there are less banks. We've seen a consolidation in banking. While failures are smaller by number, they are bigger when they occur.

  2. Your list of causes of the housing bubble is accurate, though incomplete. I'd add:
    1) 1997 change in real estate capital gains tax.
    2) Tech stock bubble and decline (with all associated policies that led to it)
    1&2 combined to encourage individuals to put an ever-increasing portion of their net-worth into real estate. This was also encouraged by irrational public subsidy of real estate in the form of the mortgage interest deduction.
    3) The mixed mission of GSEs to encourage home ownership.


    Second story

    How A Clinton-Era Rule Rewrite Made Subprime Crisis Inevitable

    Terry Jones
    Wed Sep 24, 7:19 PM ET

    One of the most frequently asked questions about the subprime market meltdown and housing crisis is: How did the government get so deeply involved in the housing market?

    The answer is: President Clinton wanted it that way.

    Fannie Mae and Freddie Mac, even into the early 1990s, weren't the juggernauts they'd later be.

    While President Carter in 1977 signed the Community Reinvestment Act, which pushed Fannie and Freddie to aggressively lend to minority communities, it was Clinton who supercharged the process. After entering office in 1993, he extensively rewrote Fannie's and Freddie's rules.

    In so doing, he turned the two quasi-private, mortgage-funding firms into a semi-nationalized monopoly that dispensed cash to markets, made loans to large Democratic voting blocs and handed favors, jobs and money to political allies. This potent mix led inevitably to corruption and the Fannie-Freddie collapse.

    Despite warnings of trouble at Fannie and Freddie, in 1994 Clinton unveiled his National Homeownership Strategy, which broadened the CRA in ways Congress never intended.

    Addressing the National Association of Realtors that year, Clinton bluntly told the group that "more Americans should own their own homes." He meant it.

    Clinton saw homeownership as a way to open the door for blacks and other minorities to enter the middle class.

    Though well-intended, the problem was that Congress was about to change hands, from the Democrats to the Republicans. Rather than submit legislation that the GOP-led Congress was almost sure to reject, Clinton ordered Robert Rubin's Treasury Department to rewrite the rules in 1995.

    The rewrite, as City Journal noted back in 2000, "made getting a satisfactory CRA rating harder." Banks were given strict new numerical quotas and measures for the level of "diversity" in their loan portfolios. Getting a good CRA rating was key for a bank that wanted to expand or merge with another.

    Loans started being made on the basis of race, and often little else.

    "Bank examiners would use federal home-loan data, broken down by neighborhood, income group and race, to rate banks on performance," wrote Howard Husock, a scholar at the Manhattan Institute.

    But those rules weren't enough.

    Clinton got the Department of Housing and Urban Development to double-team the issue. That would later prove disastrous.

    Clinton's HUD secretary, Andrew Cuomo, "made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis," the liberal Village Voice noted. Among those decisions were changes that let Fannie and Freddie get into subprime loan markets in a big way.

    Other rule changes gave Fannie and Freddie extraordinary leverage, allowing them to hold just 2.5% of capital to back their investments, vs. 10% for banks.

    Since they could borrow at lower rates than banks due to implicit government guarantees for their debt, the government-sponsored enterprises boomed.

    With incentives in place, banks poured billions of dollars of loans into poor communities, often "no doc" and "no income" loans that required no money down and no verification of income.

    By 2007, Fannie and Freddie owned or guaranteed nearly half of the $12 trillion U.S. mortgage market -- a staggering exposure.

    Worse still was the cronyism.

    Fannie and Freddie became home to out-of-work politicians, mostly Clinton Democrats. An informal survey of their top officials shows a roughly 2-to-1 dominance of Democrats over Republicans.

    Then there were the campaign donations. From 1989 to 2008, some 384 politicians got their tip jars filled by Fannie and Freddie.

    Over that time, the two GSEs spent $200 million on lobbying and political activities. Their charitable foundations dropped millions more on think tanks and radical community groups.

    Did it work? Well, if measured by the goal of putting more poor people into homes, the answer would have to be yes.

    From 1995 to 2005, a Harvard study shows, minorities made up 49% of the 12.5 million new homeowners.

    The problem is that many of those loans have now gone bad, and minority homeownership rates are shrinking fast.

    Fannie and Freddie, with their massive loan portfolios stuffed with securitized mortgage-backed paper created from subprime loans, are a failed legacy of the Clinton era.

  4. But it wasn't Clinton who allowed securitized loans to be rated aaa and who refused to regulate. It wasn't Clinton who allowed investment banks to leverage up to 40 to 1 when it was 12 to 1.

    Bush needed the money for Iraq. He got it and we are where we are. The neocons and the fed have their fingerprints all over the war for oil and the push for adjustables.

  5. It is funny how in the comments above, anonymous mentions Clinton's signing of bills and passes. However, failed to mention the bill signed by Bush in 2001 to approve the mess we are in today. You mention 49%? Truly, I would like for you to find out how much of that 49% within that time frame is really bad debt today. To add some statistics to that, the low-income loans that were approved during that time were REGULATED. These loans are called FHA loans. They require full documentation and a down payment. Far beat from providing no documenation and no equity in the crap that was loaned during Bush's adminstration. But on top of that, it is interesting that you have 49%, but in fact 60% of the mortgage bust that we are in happened between 2004-2006. A "measly" 2 years during Bush's administration compared to your almost eight years of trying to point the finger at Clinton. Surely do not believe he triggered this mess nor put us in it! Bush is like all the other Presidents out there. Greedy and only in it for himself. He should be impeached. He is by far the worst president we have ever had.

  6. oh well that's funny because wasn't Bush the first person to introduce a plan to regulate these loans with fannie and freddy in 2003? Oh and wasn't it Republicans including John McCain who in 2005 came up with a plan that may not have got us completly out of our mess we have, but it definatly would have made things alot beter. But who shut this down? a few republicans and almost all the democrates. Hey and guess what? if you dems would have listened to bush 7 years ago with his offshore digging, we would be making enough money in oil to start paying our defisate and I seriously dought this would have happened with such a big money flow oil provides.