The Blame Bubble

Deregulation Zealots Should Look In The Mirror

Recently, Kevin O'Brien of The Plain Dealer wrote an opinion piece making some observations about the current financial crisis. It was, in a word, startling. After admitting that he doesn't know much about finance, he proceeded to assess blame for the current crisis, without once using the word deregulation. That's like trying to talk about being a Cleveland sports fan without ever using the word frustration.

O'Brien, taking his cue from Sean Hannity and other ideologues who have been advancing similar explanations, rounds up several suspects. First, he blames the Community Reinvestment Act. That law, passed in 1977, basically told banks that they had to make loans to people who had previously been redlined and excluded from access to credit (primarily racial minorities and low-to-moderate-income borrowers). Of course, CRA did not tell banks to ignore prudent lending practices or the creditworthiness of borrowers. It did not tell banks to make loans without accurately assessing the values of the properties. But in O'Brien's world, it makes sense to blame a law intended to remedy past discrimination because it sounds like some "liberal" agenda. Never mind that, according to now-deceased Federal Reserve governor Edward Gramlich, banks actually made money on their CRA-mandated loans.

And more important, the vast majority of subprime loans that contributed to the current meltdown was made by mortgage brokers who were not subject to CRA at all. These loans, totaling more than $4 trillion, were motivated only by greed and the knowledge that these toxic mortgages would be packaged and sold off by Wall Street to unsuspecting investors.

Next, the blame is laid at the feet of Fannie Mae and Freddie Mac. These agencies did wield great political power and probably were no longer as necessary to the housing market in the 2000s as they had been earlier. But the classic argument that conservatives made against those two quasi-governmental agencies was that other private investment entities could perform their mission just as well. In light of the lack of prudence shown by banks and investment firms, can these critics really believe that if someone else had been buying up those home loans, things would have turned out differently?

It is true that the existence of these agencies helped to overheat the housing market. But there were all sorts of reasons why the housing market overheated, starting with the $120 billion a year subsidy of housing in the form of the home mortgage interest deduction. This favorable tax treatment led to more money chasing housing than would otherwise be the case in a free market. O'Brien, Hannity and other conservative commentators can't label that as a Democratic Party plot, since it enjoys bipartisan support, so it escapes their wrath.

So too does a monetary policy led by Alan Greenspan (a disciple of libertarian Ayn Rand). Under Greenspan, the Fed kept fueling the overheated housing market with extremely low interest rates, refusing to "take away the punch bowl" as the housing bubble kept growing.

The conservative analysis also ignores the effect of deregulating the large commercial banks. There is no place in their version of history for the 1998 repeal of the Glass-Steagall Act. The rollback of this Depression-era legislation allowed investment banks and retail banks to merge their operations, with predictable consequences. Also missing is any reference to legislation rammed through by then-Sen. Phil Gramm that allowed a new financial instrument called the credit default swap to thrive (for more on this, see "Crude" on page 11). This unregulated form of insurance single-handedly caused the recent collapse of AIG, one of the signal events that forced the government to step in.

Nor do conservatives like to talk about Securities and Exchange Commission Chairman Chris Cox and his decision to decline an offer from Congress of greater regulatory power and more staffing to try to keep up with the fast-changing financial markets. Cox didn't see the need for more regulation. On September 26, The New York Times reported that Cox, "a longtime proponent of deregulation, acknowledged … that failures in a voluntary supervision program for Wall Street's largest investment banks had contributed to the global financial crisis, and he abruptly shut the program down."

There is plenty of blame to go around; Congressional Democrats and Republicans were asleep at the switch. But the cause of deregulation was advanced by O'Brien and his anti-government intellectual soulmates, not by the champions of fair lending practices nor the advocates of more widespread home ownership. We now see the unintended consequence of failure to regulate - a massive, unprecedented governmental intervention in our economy. To address the current problems, we first need to diagnose the causes. And we should try to do that without ideological blinders.

Howard Katz is a professor of law at Elon University in North Carolina. A former Clevelander, he served as director of strategic planning for county Treasurer Jim Rokakis. [email protected]

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