BALI — Claims that “unbridled capitalism” is behind the current credit crunch and financial turmoil are misleading and remarkably uninformed. This is usually accompanied by suggestions that “blind faith” in market self-regulation was a handmaiden in this mess. We are then told that the future must involve greater political management of capitalism.
It’s as if adding one hollow assertion (unsupported by fact) upon another and then repeating them endlessly will somehow change reality. These assertions involve canards of epic proportions, because the reality is that politically imposed checks and balances are the status quo.
Indeed, managed capitalism has been the aim of most modern governments ranging from social democrats to national socialists as well as so-called liberal democracies. In most instances, constraints on markets were the result of self-serving populism used to boost electoral support.
A presumption that global financial distress arose from unrestrained management of capital using high degrees of leverage willfully ignores the role of loose monetary policies. As it is, artificially cheap credit conjured up by central bankers undermined the notion of risk and provided the excessive liquidity to pump air into the bubbles.
Believing that recent decades were marked by an orgy of deregulation and the retreat of government intervention requires a complete suspension of any sense of reality. Despite strategic retreats by governments to liberalize trade and capital flows, most government budgets increased at a rate faster than economic growth.
As such, the trend has been for more regulations with more government and international agencies overseeing economic activity with more public-sector spending. Perhaps because it is considered the epicenter of recent financial storms, the situation in the U.S. is depicted as an “orgy” of financial deregulation. Instead, most recent legislation affecting financial firms imposed heavier regulatory burdens while expanding powers of federal agencies.
Consider that the underlying basis of the ongoing financial funk can be found in the Community Reinvestment Act (CRA) of 1977. It pressured banks to ignore the size of a mortgage payment relative to income, credit and saving history or income verification. Instead, creditworthiness became based on participating in “credit-counseling” programs.
While the CRA obliged mortgage lenders to arrange loans for people who were without sufficient means to repay, it was reinforced by the Gramm-Leach- Bliley Act of 1999. And the American with Disabilities Act of 1990 amended the Fair Housing Act of 1968, adding disability and family status as nondiscrimination criteria in mortgage lending. In sum, legislation that forced banks to make risk secondary to social factors helped set the stage for the subprime problem.
Meanwhile, banks and financial firms faced new obligations under the Crime Control Act of 1990 that increased the powers of the FDIC by specifying new regulatory crimes. The Federal Deposit Insurance Corporation Improvement Act of 1991 increased the powers and authority of the FDIC while the Federal Deposit Insurance Reform Act of 2002 increased its discretion.
As such, it is disingenuous to interpret this as a wave of deregulation of banks or the retreat of government from oversight. At the same time, other financial firms were targeted by new legislation that involved more power to federal agencies.
For example, the Commodity Futures Modernization Act required the SEC to intervene to promote “fair” competition. Under the Sarbanes-Oxley Act, the SEC set costly “governance” requirements and forced financial firms to follow detailed accounting rules like mark-to-market valuation.
The most obvious indicator of greater regulation may be seen in budgetary allocations of regulatory agencies. Budgets for agencies overseeing finance and banking (Federal Reserve, FDIC, National Credit Union Administration, Farm Credit Administration and Federal Housing Finance Board) are up 15-fold over the past 50 years (in constant dollars for 2000).
The total budgets for the Comptroller of the Currency, FinCEN and Office of Thrift Supervision rose by a factor of 10 over the same period. And the budget of the SEC was doubled and given the most personnel in its history; it received greater authority to oversee accounting practices under the Bush administration.
Other assertions that government officials were not sufficiently fulfilling their obligations suggest the problems arose from empowering the wrong individuals. While such regulatory failures are evident from historical evidence, they are predicted by economic theories of regulation.
As such, the tendency for regulatory failure does not depend on the stated aim of legislation or the intention of legislators or the character and values of bureaucrats. Instead of imposing more onerous burdens of regulation, a simple and better mechanism is available to curb the creation of hyper-inflated financial bubbles.
Again, history and theory have shown that bubbles and artificial booms are caused by central bankers creating excessive liquidity on the back of artificially cheap credit.
In the end, central banks must refrain from tampering with monetary growth as a tool to manage the economy.
Christopher Lingle is a research scholar at the Center for Civil Society in New Delhi and a visiting professor of economics at Universidad Francisco Marroquin in Guatemala.
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