When Wall Street collapsed, most people blamed the banks. Conservatives blamed the government. (More)

More, More, More, Part II: Deregulation

This week Morning Feature considers the curious conservative belief that the solution to many problems is more of the same problem. Yesterday we looked at their view on mass shootings. Today we examine the Wall Street crisis and financial regulation. Saturday we’ll conclude with deficits and tax cuts.

Once Upon a Time …

… in the lush Garden of Enterprise, people were free to do as they wished. Guided by the invisible hand of the free market, each acting in rational self-interest to maximize his or her individual utility, sharing complete information and with zero transaction costs, the people combined to build the Pareto Bridge to an optimal utopia. There every buyer found a seller and every seller a buyer, every employer found workers and every worker found employers, wages and prices were stable, investment and hard work were rewarded, goods and services were distributed efficiently, and neither fraud nor sloth could exist. From high atop the Pareto Bridge, Adam Smith looked down and saw that it was good.

The people would have lived happily ever after, but government slithered into the garden and tempted them with promises of equality and offers of social welfare. Then darkness swept across the land and the people became lazy and selfish. And Adam Smith looked down and wept….

The conservative economic myth isn’t quite that poetic, but it’s close.

Regulations caused the Wall Street collapse?

Consider this article by John Maalouf in CEO Quarterly:

The ill conceived and poorly executed regulations imposed upon the financial services industry over the past eight decades are the direct and proximate cause of the current turmoil taking place on Wall Street.

Although regulations that are specifically tailored to curtail certain types of malfeasance on the part of a small number of companies is beneficial to the economy at large, the ‘shot-gun’ approach favored by legislators over the years has caused far more harm to Wall Street and to the global economy than good.

Maalouf goes on to argue that the Glass-Steagall Act “had the effect of weakening the entire U.S. banking sector by putting it at a substantial competitive disadvantage when compared to banks in the rest of the world which were still able to offer ‘Universal Banking’ services to their customers” … without mentioning the decades without a banking crisis.

The Wall Street Journal‘s Peter Wallison told a similar myth:

Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007.
As housing bubbles grow, rising prices suppress delinquencies and defaults. People who could not meet their mortgage obligations could refinance or sell, because their houses were now worth more.

Accordingly, by the mid-2000s, investors had begun to notice that securities based on subprime mortgages were producing the high yields, but not showing the large number of defaults, that are usually associated with subprime loans. This triggered strong investor demand for these securities, causing the growth of the first significant private market for MBS based on subprime and other risky mortgages.

The problem wasn’t financial alchemists devising derivatives so complex that only the alchemists themselves could understand them, then pushing the ratings agencies for investment-grade AAA marks, the same ratings agencies that relied on the alchemists for their incomes, the same alchemists who then took out insurance bets against the very derivatives they sold to pension fund managers, municipal governments, and others in search of safe, reliable investments. Only the “gullible Occupiers” – and perhaps “the college kids, the baby sitters, and the nails ladies” – would believe such a silly tale.

The problem was that working families refinanced their mortgages – leaving investors without efficient market signals that housing prices were in a bubble – rather than defaulting and losing their homes. “You people” can be so thoughtless….

The power of myth

No conservative believes the Garden of Enterprise ever existed. But most conservatives believe that optimal utopia could exist, and would, if only government would get out of the way. As we’ll discuss in depth next week, that utopia is predicted by neoclassical economic theory. Indeed it can be proved with mathematics …

… if you assume those rational economic individuals – neoclassical theory ignores corporations and cartels leveraging economies of scale to distort markets to their advantage – each acting in self-interest to maximize his or her individual utility, sharing complete information and with zero transaction costs. You also must assume that every good or service of a given type is indistinguishable from other goods and services of that type, and that every individual will settle for an equal portion of every type of good and service.

If you assume all of those non-facts, then the mathematics prove the Garden of Enterprise would produce the optimal distribution of goods and services, with no need for government.

Thus, conservatives say government should help turn those assumptions into actual facts, by getting out of the way and letting the free market work. Any economic problem, then, can be traced to the actions of government … and the solution to an economic collapse made possible by deregulation is … more deregulation.

More, more, more….


Happy Friday!