Imagine thousands of years ago a historian with religious inclinations observing the destruction of Pompeii. Those reading the history later would be convinced that the sinners of the city angered the gods and were punished for it and immortalized in liquid magma. A seismologist would for instance have a very different take on the situation.
Economic calamities are no different, like the Great Depression. Students and casual hobbyists have been "taught" for decades that speculation, greed and the collapse of the stock market somehow caused an eight year slump in America while bringing international financial markets to their knees. It took many decades for economists to begin breaking down the true causes through the works of people like Friedman and far more accurately, Murray Rothbard, but the damage had been done.
To that end, while the wounds are still fresh, it helps to revisit this very crucial historical event despite the fact that legislation like Dodd-Frank has already been rushed out to supposedly fix what was broken.
So what is the number one cause for the 2008 Housing crisis as far as the layman is concerned? Well of course it is deregulation. So many have written about it, movies have been made about it and the conviction is so unshakable that even disputing it seems like lunacy. You would think that the accusers would provide a lengthy list of legislation that proves their case, but alas, there is only one offending piece.
The notorious Gramm-Leach-Bliley Act. That is it! So let us take a look.
The Wiki cites several criticisms:
Many believe that the Act directly helped cause the 2007 subprime mortgage financial crisis. President Barack Obama has stated that GLB led to deregulation that, among other things, allowed for the creation of giant financial supermarkets that could own investment banks, commercial banks and insurance firms, something banned since the Great Depression. Its passage, critics also say, cleared the way for companies that were too big and intertwined to fail. Economists Robert Ekelund and Mark Thornton have also criticized the Act as contributing to the crisis. They state that "in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance" the Financial Services Modernization Act would have made "perfect sense" as a legitimate act of deregulation, but under the present fiat monetary system it "amounts to corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly."The critics range from the standard Leftist talking points (including economic laureate Barack Obama..oh wait) to more nuanced observations from Thornton that suggest we simply could not afford a free market because we have too many broken things in our system. Interesting thought. Let's work with that.
So supposedly GLB is such a reverse to free market principles that America simply was unable to cope. Really?
Are we supposed to believe, that a bill that was signed by then president Bill Clinton and supported by 155 House Democrats (out of 206) and 38 Democrat Senators (out of 45) was a massive lurch to deregulate and bring back the free market?
So what exactly did this giant deregulation bill do? I am going to refer to Golden State blog, an economist who reviewed the movie Inside Job:
The best they can do [Inside Job narrators] is to cite the partial repeal of the Glass-Steagall Act in 1999, and even this argument weakens on examination. The repeal (known as Gramm-Leach-Bliley) merely eliminated a provision that prohibited commercial banks and investment banks from existing under the same corporate umbrella, a provision that exists nowhere else in the world; other elements of Glass-Steagall, including those prohibiting commercial banks from underwriting or trading in securities and those prohibiting securities firms from taking deposits, were left intact, and other laws exist to prevent investment banks from unloading toxic securities onto commercial affiliates.So all it did, was remove that one provision and allowed the merging of the banks. Bill Clinton stood by that provision and cited that without it, it would have been impossible in the wake of the 2008 crisis for distressed companies to be purchased by each other. More importantly, that provision was largely being circumvented anyway. I remember looking at this information back in 2008 and found revealing information from Cato to suggest that the point was truly moot:
Even before its passage,investment banks were already allowed to trade and hold the very financial assets at the center of the financial crisis: mortgage-backed securities, derivatives, credit-default swaps, collateralized debt obligations. The shift of investment banks into holding substantial trading portfolios resulted from their increased capital base as a result of most investment banks becoming publicly held companies, a structure allowed under Glass-Steagall.going on to say
Second, very few financial holding companies decided to combine investment and commercial banking activities. The two investment banks whose failures have come to symbolize the financial crisis, Bear Stearns and Lehman Brothers, were not affiliated with any depository institutions. Rather, had either Bear or Lehman possessed a large source of insured deposits, they would likely have survived their short-term liquidity problems.This is incidentally, exactly the same debate that was had in Congress in the 1930s! The passage of Glass-Steagall as far as it separated the commercial and investment banking was never ever explained. It was simply stated that it needed to be done and became one of the many provisions of G-S. As I have researched the matter previously, I shall link to my own previous article, but the fact remains:
Interestingly enough, unified banks (those with investment arms) from 1927 to 1930 greatly increased their issuance of bonds, solid proof their businesses were strong and more trusted than just purely commercial or investment banks alone. Another study quoted in Tabarrok's research suggested that unified banks simply issued higher quality securities than exclusive Investment banks. So if there was no empirical reason for separating the commercial and investment banks, then what is the explanation behind Glass-Steagall?I encourage you to read the history of G-S as it exposes how large private corporations can influence and write regulation, regulation that is then deemed to somehow be beneficial to the consumer, but in reality is used as a bludgeoning tool for one private entity against another.
Lastly, I have one last piece of evidence to present. Presumably, if this was truly a lurch to deregulate and a move to a free market as many claim, then at the time of passage it would be logical to assume that the one Congressman who constantly beat the drum for the raw free market would support it. However this lone Congressman opposed it and although his original letter has been lost, a copy can be found here:
CONFERENCE REPORT ON S. 900, GRAMM-LEACH-BLILEY ACTI have removed a few unrelated paragraphs for brevity, bolded text is mine.
HON. RON PAUL
Madam Speaker, today we are considering a bill aimed at modernizing the financial services industry through deregulation. It is a worthy goal which I support. However, this bill falls short of that goal. The negative aspects of this bill outweigh the benefits. Many have already argued for the need to update our financial laws. I would just add that I agree on the need for reform but oppose this approach.
Such a scenario would put added pressure on the financial bubble. The growth in money and credit has outpaced both savings and economic growth. These inflationary pressures have been concentrated in asset prices, not consumer price inflation--keeping monetary policy too easy. This increase in asset prices has fueled domestic borrowing and spending.
Government policy and the increase in securitization are largely responsible for this bubble. In addition to loose monetary policies by the Federal Reserve, government-sponsored enterprises Fannie Mae and Freddie Mac have contributed to the problem. The fourfold increases in their balance sheets from 1997 to 1998 boosted new home borrowings to more than $1.5 trillion in 1998, two-thirds of which were refinances which put an extra $15,000 in the pockets of consumers on average--and reduce risk for individual institutions while increasing risk for the system as a whole.
The better alternative is to repeal privacy busting government regulations. The same approach applies to Glass-Steagall and S. 900. Why not just repeal the offending regulation? In the banking committee, I offered an amendment to do just that. My main reasons for voting against this bill are the expansion of the taxpayer liability and the introduction of even more regulations. The entire multi-hundred page S. 900 that reregulates rather than deregulates the financial sector could be replaced with a simple one-page bill.
There are three critical takeaways here.
First, Ron Paul in 1999, already warned that the economy is accumulating a lot of risk and that people are chasing assets - a natural consequence of easy credit expansion promulgated by our central bank and policy makers.
Second, and more importantly, is that he saw the bill as MORE regulation. Not LESS. He identified a moral hazard and realized that taxpayers will be on the hook in case of failure. This is precisely what was happening with all attempts to rein in Fannie and Freddie, two agencies that were strong armed by the Government to facilitate loan processing. However the "American dream" was not to be derailed, even if it required massive social engineering to achieve it.
Third and MOST important, he identified and spoke of an impending bubble and bust. What did he see and what he was warning about? Why did he believe that this bill would exacerbate the existing financial bubble. This is precisely the root of the entire problem. This is what the economists who criticize GLB by suggesting that our markets cannot handle the legislation are trying to so poorly convey. We have a very serious structural problem. I would argue that band-aids like Glass-Steagall and Gramm-Leach-Bliley are nothing more than weak attempts at solving distortions created by centrally planning interest rates and forceful expansion of credit.
As Ron Paul said in his closing statement, if Congress were truly to repeal the bill, it would take one page. Instead, GLB is huge clocking in at over 140. Curiously enough, Glass-Steagall is 37 pages.
So, the narrative goes something like this.
Crazy free-market libertarians passed a 140+ page bill that repealed 37 pages of Glass-Steagall (insert confused face here) with the help of 155 House Democrats and 38 Senate Democrats signed by a Democrat president. Only to be opposed at that time, by the only self-proclaimed libertarian in the House on the grounds that this was not deregulation, but simply new regulation.
Do you now see the absurdity of it all? But of course it is easy to understand the allure of it all.
Something like 2008 and the Great Depression and all seismic collapses are difficult to fathom and understand. Especially when you consider just how illiterate most are on Economics, combine that with the fact that even economists themselves blame GLB and you got yourself a very explosive scapegoating situation. People always look for the easiest and simplest solution to their problems.
Sure you can point to this bill and you can point to the greed of Wall St (apparently greed never existed before 2008) and pat yourself on the back for a job well done, but it requires far more time to appreciate why the collapse occurred and what to do to prevent it from ever happening again.