Wednesday, October 22, 2008

Deregulation didn't cause the financial crisis

Democrats, and the Democrat-friendly press, have been very eager to blame the financial crisis on deregulation. However, Wharton Business School finance professor Jack Guttentag says deregulation didn't cause the financial crisis.
Deregulation, meaning the scrapping of existing regulations, was not a factor in the crisis. The only significant financial deregulation in the past three decades applied to commercial banks. Restrictions on where they could have branches and on their involvement in investment banking were both removed. Most economists, including me, believe that these actions made the banks stronger than they would have been otherwise.

Regulation in itself is a weak defense against financial crises. One major reason is that it tends to look backward, similar to generals fighting the last war. ...

Regulators have no better foresight than do the firms they regulate. Both use statistical models based on experience. A change in the underlying structure of the economy can make such history irrelevant, which is exactly what has happened. Nobody anticipated the severity of the current crisis because, relative to the past, it is off the chart. ...

Can we prevent this sort of problem from happening again? Yes, but the next crisis will almost certainly be different.
Remember that the next time you see CNN blaming Phil Gramm for this mess, without any hard evidence. I dislike Phil Gramm, but he is not responsible for the current troubles.


  1. Lack of regulatory oversight was a main reason and, in my opinion, the primary reason for the calamity.

    I doubt the professor disagrees with that. With regulation foes in charge, oversight lapsed, few new regulatory controls put in place or those there enforced vigorously.

    This is a non-story, but thanks for the clarification.

  2. Disagree.
    The lack of regulaton occurred at the level of the US citizen. There would be no crisis if citizens has practiced better fiscal policy.

  3. Darwin,
    True, but incomplete. Wouldn't regulation of new markets such as CDS have helped avert this. Wouldn't stricter rules on allowable leverage at investment banks? Regulation of hedge funds? Wouldn't tighter regulation on FNM, FMC?

    All contributed.

  4. I'm going to wave my BS flag here

    So when the Fed Gov't loosened the leveraging restrictions on investment backs 4 years ago because the computer models said "It's ok, things will never crash" this had NOTHING to do with the financial crisis? Really?

  5. The crisis happened because of insane lending standards. The reason banks were offering the ridiculous loans was because they weren't holding the risk, they would just process the loan, collect their fees and then sell the loans to wall street. It was obvious to anyone paying attention, including this blog, that this couldn't go on forever. It could have been stopped with some regulation, but people didn't want it to stop, they wanted to continue their refinancing cycles. Propaganda from people like David Lereah was driving the psychology while the regulators where asleep at the wheel.

    This type of B.S. from the "Wharton Business School finance professor" is part of the problem. It's the "government is too stupid to regulate us super-smart business people" theory. Well you know what, Mr. Guttentag? Fuck you. While this blog was writing in 2005 that "The bubble will burst soon" Mr. Guttentag was giving advice on buying houses into 2007. But now we're supposed to listen to him about regulation?

  6. "Nobody anticipated the severity of the current crisis because, relative to the past, it is off the chart. ..."

    Really? Nobody anticipated the severity of this downturn? This is BS as well. Loads of people did. I'm sure Guttentag was too busy showing disdain for those people and their arguments.

    Sorry, this whole thing was caused by the abdication of regulatory responsibility from the Republican government. Plain and simple.

    The Republican-led government allowed over-leveraged investment banks, they allowed (and encouraged) irresponsible and predatory lending and they allowed the multi-trillion dollar shadow derivatives market to grow to economy threatening proportions.

  7. Credit is like an addiction - who do you blame, the addict or the pusher?

    I still blame average Americans who extended themselves beyond their means. yes, "predatory" lending required "prey" - prey in this case was the millions of idiots who overdosed on credit...unortunately, we are keeping the stupidity gene a viable trait, by pumping nmore drugs (credit) into the system.

  8. A failure to enforce EXISTING regulations has the same effect as deregulation. 6 of one, half a dozen of another. Just semantics.

    What's the difference between a security guard paid to look the other way and not having any security guard? Not a whole lot.

  9. Darwin,

    Feel free to blame the average American that overextended themselves.

    But you must also blame the investment bankers who overextended themselves and their companies.

    Is was their gorging on credit and willingness to leverage themselves up to 30x that turned this into a global financial crisis.

    Without that absurd leverage, it likely that we would only be talking about large writedowns and Bear Sterns and Lehman would still exist.

  10. Darwin,

    You are mixing apples and oranges.

    The individuals buying homes at ridiculous prices suffer from their folly. Not much regulation, if any, is needed.

    The issue is the financial crisis. Regulation is needed because the folly of the banks can lead to calamities that affect not just the banks, but the entire economy. As such, it is and should be regulated. If it only affected banks, without harming the foundations of the economy, it wouldn't need to be regulated. There is a difference.

  11. Sorry, but the Wharton dude has no idea about what's been going on.

    Lots of regulators were paid lots of money to regulate banks over the last 8 years. What the F were they doing?

    They couldn't spot that Option Arms might be contributing to bad loans? The fact that real estate was going up 20% or more annually? That didn't cause some concern?


    I think it's about time for a little accountability. These people need to start saying "Why didn't we anticipate this???"

  13. Yeah, right, nobody could have seen this coming. Give me a break. The regulators took a chain saw to the rules. Capitolism does not work without rules.