Classical Values :: Was everything really "deregulated"? So why do we all have to pay?

October 05, 2009

Was everything really "deregulated"? So why do we all have to pay?

While I have nothing against morality per se, sometimes an overabundance of morality can get in the way of analysis, and this is especially true in economic analysis.

So, while I'd like to say that I think that the biggest problem with capitalism is socialism, these concepts are so dripping with morality that it's tough to talk about them in objective terms. The fact that capitalism is said to be "greedy" (think widows and orphans evicted at Christmas time), or that socialism and Communism are responsible for the deaths of 100 million people -- these things connected to the isms are emotional and tend to get in the way of efficacious discussions of what is going on.

Even calling a free or unregulated market "capitalism" is problematic, as it is imitative of the Marxist approach. Communism is an "ism," and multiple volumes are devoted to what it is, and how to implement it. The word "capitalism" is largely a Marxist meme, and it distorts the idea of an unregulated marketplace into something that becomes a system, with planners, managers, economists, MBAs, CEOs, CFOs, and finally government bureaucrats -- who become collectively those who control "Capitalism."

I know I am a curmudgeonly person who hates change, and I often doubt whether I am a "conservative," but I can't help notice the way "deregulation" has become a dirty, almost evil word. Things have reached the point now where if you talk about the desirability of the free market, and complain about government regulation, people will roll their eyes as if you're hopelessly out of touch with reality. That's because we all know what deregulation did, don't we?

Think about deregulation. What does it really mean? That something was regulated, and the regulations were eliminated or loosened. But in a true free market setting, there would be no need to talk in terms of deregulation, because there would have been little or no government regulation of the marketplace to begin with.

What really bothers me, though, is the way the current economic crisis is being spun as having been caused by deregulation (especially deregulation of the banking system) having run wild. In logic, this boils down to seeing the free market as the culprit, and the freer the market is, the more dangerous things will be. Naturally, the way out of this mess is to regulate, regulate, and re-regulate. As to the other side, people seem too intimidated to speak up. Almost like the deer caught in the headlights syndrome -- as if they believe the lie that they and their free market ideas are to blame.

They are not only being given a severe scolding, but they are taking it as if they deserve it. They are acting like a group of errant husbands caught by their wives at an orgy. Not to dwell on sexual matters again, but I worry about psychological factors sometimes, and I think the dynamics of what I've called "economic hedonism" are similar. And the way the word "deregulation" is being used in a blatantly Puritanical manner, it clearly denotes economic hedonism. Seriously, it's as if they're saying, "Your orgy is over and now the whole country has AIDS!"

As Paul Krugman is fond of saying, the "grownups" now need to be in charge!

I'm no economist, but the problem is that deregulation is being seen in a vacuum, without reference to the bigger picture, and I think the bigger picture was influenced -- possibly even dominated -- by something worse than regulation.

I refer to the complete absence of any standards. Not long ago, Glenn Reynolds made a nostalgic reference to the stuffy uptightness of old-fashioned bankers:

You know, we may just find that all those "stuffy" and "uptight" traits that old-fashioned bankers used to be mocked for were actually a good thing. . . .

Truer words have never been spoken and I've blogged about this before. It used to be that you had to actually qualify for a loan. You had to demonstrate income, creditworthiness, equity in the home, that the downpayment wasn't borrowed, etc. before the stuffy uptight pinstriped guys would even think about giving you a loan. It was good that they were uptight. The "system" (for lack of a better word) worked.

So, what made these stuffy uptight guys decide they could get away with ditching the old uptight unfair standards that said (among other things) that some people are more worthy of getting loans than others?

The answer, as most of us know, is the government. It wasn't as if these guys just stripped off their pinstripes and dove into the economic orgy room; they did something that's really perfectly in character for stuffy uptight guys -- they did as they were told. And they were told not to ever under any circumstances do anything that might in any way be interpreted by anyone at ACORN to have so much as a smidgen of an appearance of anything resembling discrimination. (A word denoting pure, unmitigated evil.)

Bad as the loss of banking standards might be, it's not what I think is the overarching problem.

In my view, the biggest the loss of standards came in the form of the all-encompassing government guarantee. It was a gigantic blank check, and it operated to cover all sins. That no bank could ever be allowed to fail, and every mortgage would be backed by big daddy at FANNIE and FREDDIE meant that there really was no downside to anything, whether deliberate irresponsibility or government-mandated irresponsibility. The taxpayers would be responsible.

This may be many things, and it may of course be profoundly immoral, but to call it "deregulation" or "an excess of the free market" is absurd.

To illustrate how absurd it is, imagine if schools were mandated (under the theory that grades were evil and discriminatory) to make it Impossible To Fail, so that henceforth, no one would fail and everyone would get an A. Eventually, teachers would have no incentive to teach, students would have no incentive to learn, and the educational system itself would fail.

No failure thus would mean universal failure.

I realize grades are not an economic issue, so let's stick with the blank check analogy until we carry it to the point of absurdity, by applying it to every person and all economic activity within the United States.

Every person gets an unlimited blank check in the form of a government account (the social security account number will do), on which he is allowed to write checks for anything he wants in unlimited amounts, with the taxpayers simply all footing the bill owing all money on behalf of each other. While this might initially be good for the economy, it would not take long for total bankruptcy to set in, and the very predictable result would be that the government would simply own everything.

By any stretch of the imagination could such an insane "system" be called "deregulation" or the "free market"? I don't see how, and I think that once anything is backed by a blank check, what you get is a very sinister form of regulation which quite insidiously doesn't seem like regulation; it seems like the very opposite.

When people (or entities like banks) are given government guarantees, that amounts to a blank check which will transform virtually anything they do into what I believe economists would call "risk averse" activity. Meaning that from a free market perspective there is no downside to them. It may be everyone else's downside, but it is not their downside. Because ultimately, it is not their money that's at risk.

It is the height of dishonesty to characterize their behavior as the "free market." There is nothing free about being underwritten by the government, and because taxpayers are forced to foot the bill, it is in fact a profound distortion of the market. A market operating on money which people were forced by the government to pay in cannot be called free. And on a personal level, if I am given a financial guarantee that the taxpayers will be forced to bail me out of anything I do, nothing I do with that money (a guarantee is virtually money) is free, and it is absurd to characterize my behavior as the result of "deregulation."

I wish they'd be nice and stop calling it that.

UPDATE: My thanks to Glenn Reynolds for the linking and quoting this post, and a warm welcome to all!

Your comments are invited, agree or disagree.

By the way, since I mentioned Paul Krugman remarks about putting "grownups" in charge, I thought it's worth noting that he's still quote fond of characterizing his opponents as children. From his October 5 column:

...the modern conservative movement, which dominates the modern Republican Party, has the emotional maturity of a bratty 13-year-old.

To bed without supper, you bad bad children!

AND MORE: I'm not a shrink, but I'd love it if someone could explain what makes Krugman feel so certain that he is the adult in this equation. There's just something about his repeated insistence that his critics are a bunch of children that has a seventh-grade sound to it.

MORE: Commenter Dana correctly points out that I should have said "risk indifferent" instead of "risk averse":

A certain degree of risk aversion is normal and rational. Risk indifferent is what you become when you have a sugar daddy giving you blank checks.

Absolutely right.

Of course, having a blank check removes normal risk aversion from the equation.

posted by Eric on 10.05.09 at 01:51 PM

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Comments

Eric, thanks for this explanation. It clarifies a rather muddy problem.

TimothyJ · October 5, 2009 02:21 PM

Re: schooling.

In actuality grades are only for the "average" those interested in learning will learn no matter what the obstacles. You can't stop them.

M. Simon · October 5, 2009 03:39 PM

I used the analogy of Vegas with my aunt who likes to gamble.
If nobody can lose, how can the casino pay the winners?

As for the rest, this age has been characterized by having to relearn lessons that we already knew.

Our education establishment has been taken over by leftists who hate the way the world works so they keep making up theories about how it should work that sound beautiful until they meet the real world.
Like communism. If it worked, it really would be the best system. The problem is that once people are involved it won't work without armed coercion and then it won't work well.
People aren't bees or ants.

That's why we keep seeing studies "proving" stuff we already knew. There was one that "proved" that alcohol really does lower inhibitions and the "scientists" actually sounded surprised.

Veeshir · October 5, 2009 04:45 PM

There HAS to be regulaton, Eric, because of the progressive mindset. Scratch the surface and your basic lefty is a pessimist who believes it self-evident that, left to our own devices, we will surely go astray on account of greed, prejudice and the slew of risks we are ignorant of. If someone is not firmly IN CHARGE, the greedheads will simply cart it all off.

Dem politicians long ago latched on to this fearful pessimism as a source of money and malleable minions. It scares me how deeply plugged in my lefty friends are to the officially sanctioned sources and how much cognitive dissonance they experience if the plug is played with.

Charlie · October 7, 2009 02:00 PM

Alas, the financial world is not populated by "stuffy uptight guys" but by liberal true believers. They needed no gun at their heads to cheerfully and eagerly exceed the government mandates specified in CRA.

flenser · October 7, 2009 02:01 PM

Excellent analogies and examples.

Assistant Village Idiot · October 7, 2009 02:04 PM

Socialism is just and excuse to put articulate-intellectuals in charge. When they claim that the problem du jure is greedy capitalist and that the solution is leftwing government, they are really making a statement that leftists do not have such moral failings and that we would all be better off under their wise and benevolent rule.

This will never end. The last 200 years have shown that articullate-intellectuals invent rational after rational for why they should rule, creating and disposing of new such rationals every generation and then conveniently forgetting that they had done so.

Shannon Love · October 7, 2009 02:06 PM

Anytime you hear a politician talking about "market failure" the real culprit is usually bad government policy, usually championed by that very same politician. The whole credit fiasco that came to a head last year is no exception.

As I understand things, for many years Fannie and Freddie only purchased standard mortgages (down payments in the 15-20% range with loan to value ranges 85% or lower) which were packaged together and sold as mortgage backed securities. Then a few years ago, they started buying and repackaging non-standard (sub-prime mortgages) for re-sale. Thus the housing bubble and troubled assets.

The simple fact is that Fannie and Freddie created the market for sub-prime loans which, in turn, created this debacle. Without a sub-prime after-market, virtually no one would make a sub-prime loan.

We really do have fools in D.C. and most state capitols.

Randy · October 7, 2009 02:15 PM

Heads I win, tails the government loses. What could go wrong?

peter jackson · October 7, 2009 02:27 PM

The bottom line on this is that putting people into house, that the can't afford, is a losing proposition, no matter how much regulation.

When you the White House and Capitol Hill trying to revitalize the CRA, you can clearly see that there were no lessons learned.

Neo · October 7, 2009 02:28 PM

"...these concepts are so dripping with morality that it's tough to talk about them in objective terms."

Isn't it interesting that, in so many discussions where "share the wealth" ideas are placed on a moral basis, the morality stops dead at the U.S. border. I cannot count the number of folks I have heard spouting schemes to tax or regulate "the rich" who themselves have incomes far far above the average world individual income. World-wise, they are the rich. But that ain't the idea, is it.

Stephen · October 7, 2009 02:29 PM

Contrary to "progressive" popular belief, in a free market there is no such thing as "predatory lending".

Various lenders compete against one another to offer the lowest possible rates that will still allow them to remain profitable.

More to the point, despite the often proffered excuse of "greed" (since when is ANY for-profit industry not trying to maximize profits?) banks aren't terribly interested in loaning large sums of money to individuals who are not likely to pay it back.

That didn't happen because of "deregulation" or "market failure" or "greed", it happened because of BAD regulation.

Anonymous · October 7, 2009 02:39 PM

I've pushed a few people, mid rant, to explain how exactly the banking deregulation caused this... all I got was the deer in headlights thing.

They're basically full of it.

Thomass · October 7, 2009 02:49 PM

Well said. But shouldn't "risk averse" read "risk indifferent"? A certain degree of risk aversion is normal and rational. Risk indifferent is what you become when you have a sugar daddy giving you blank checks.

Dana H. · October 7, 2009 03:30 PM

Funny how the most heavily regulated industries - finance, health, insurance - are also in the most trouble, huh? Why, it's almost as if there was some sort of cause and effect.

Fatty Bolger · October 7, 2009 03:34 PM

Actually, in my opinion it is more insidious than you write. It not only allows amoral ( not immoral ) to profit, but makes the moral people with standards unable to compete.

Once Fannie and Freddie were guaranteeing everything only lending institutions which took advantage of people were making large profits. Institutions that stick to their principles only see the benefit when the failure happens.

John Hansen · October 7, 2009 05:00 PM

As a stuffy uptight banker myself I found your point to be an excellent one, although I agree with Dana that you should rethink your usage of the term "risk averse".

Frank Petrarch · October 7, 2009 05:20 PM

Deregulation was 100% successful. Reagan, Bush Senior, and Bill Clinton deserve great credit. Not one mistake.

The problem is: as they were busy deregulating what should have been deregulated, they missed regulating some innovations in the financial field that emerged in their respective times.

At the minimum, they should have paid attention to what was being stashed in bank inventories/balance sheets, and not signing legislation that ended up polluting said balance sheets.

David M. McClory · October 7, 2009 07:47 PM

If regulation was so important to Democrats, why did they insist on exempting mortgage giants Fannie Mae and Freddie Mac from key banking regulations?

And why, once Fannie and Freddie's bad loans killed the economy, did Barney Frank insist that accountants loosenthe post-Enron mark-to-market truth-in-bookkeeping regulation?

Frank Warner · October 7, 2009 07:53 PM

We Guarantee It: The Credit Rating Agencies

Along with pressuring banks to make risky and outright bad loans, the government pressured the credit rating agencies to put AAA on that debt. Fannie Mae (and Freddie Mac) thoroughly confused the housing bond market for 20 years. Fannie Mae had the implicit guarantee of the government and many explicit privileges that connected it to the government, unlike any truly private company. The ratings agencies respected that implicit guarantee to put AAA on Fannie Mae debt. Then, they put AAA on all similar debt, because how could they say that the other debt was bad when they were saying that Fannie Mae debt was good? It would have blown the cover off the entire operation.

An "implicit guarantee" is when powerful politicians are pushing a program and clearly are not going to let it default. They will spend any amount of money to avoid bearing personal responsibility for a failure. This is how it has worked out.

Here is a quote at the above link.
( easyopinions.blogspot.com/2008/10/we-guarantee-it.html#bardo )
==================
Craig Bardo:
The failure of the ratings agencies has had consequences that are out of proportion. It should not be dismissed as a simple regulatory mistake.

I represented bond issuers and designed entire programs based on getting better ratings as well as better tax treatment for non profit issuers. Why did the ratings agencies get the mortgage securities so wrong and not the debt of hospitals, colleges, and universities I represented? Why did purchasers do better buying lower-rated health and university bonds than the higher-rated mortgage bonds?

The answer lies in political pressure. My issuers had very little power over the rating agencies. But, the federal government effectively provided the charter for the ratings agency, and the federal government tacitly backed the bonds being rated.

Even the most seasoned, hardened analyst working for the ratings agency would have a hard time stating that those bonds were not worth the paper used to print the offering document
==================

A lot of banks lost money because they bought debt that they did not understand. The government lost money through its housing policy implemented through Fannie Mae and Freddie Mac, who bought $1,400 billion ($1,400,000 million) of this subprime debt, and pressured the bond rating agencies to stamp AAA (safe investment) on all of the sub-prime debt. Fannie and Freddie were government programs pretending to be private companies. They had the implicit guarantee of the federal government.

Housing itself was pushed as a government program. Housing is a highly leveraged investment. The homeowner borrowed 80% of the money to buy the home (4:1 leverage). Great when prices are going up, and disastrous in any downturn. The leverage was more like 10:1 for the sub-prime loans. All encouraged by government policy and programs.

Andrew_M_Garland · October 7, 2009 08:25 PM

Nice post. I'm no economist either, but I'm a pretty good systems engineer. And it certainly seems likely that the normal risk/reward analysis for investors of all classes were subject to biases introduced by government influences. When they all seem to do something "stupid", it's probably because they're responding to non-obvious incentives. Their actions are probably entirely rational. Blaming it on "greed" is like blaming the crash of a poorly designed plane on "gravity".

Todd · October 7, 2009 08:47 PM