What Deregulation?

14 November 2008 at 10:07 pm Peter G. Klein 3 comments

| Peter Klein |

We noted previously a major flaw in the “deregulation-caused-the-financial-crisis” meme spreading rapidly throughout the MSM: namely, there wasn’t any. If I can quote from the comment section of another blog, here’s Jerry O’Driscoll making the same point:

[T]here has been no deregulation of the financial markets since 1999 (Gramm-Bliley Leach). And that act did not repeal the Glass Steagall Act of 1933, . . . but amended it (Sections 20 and 32 of GS being repealed), and some other banking statutes. Mostly the act legitimized financial market developments already in place, and provided a new regulatory structure (so much for deregulation).

I recognize that policy lags are long and variable, but Sandy [Ikeda] cites events from 1992, 1997 and 1999 [as drivers of the crisis]. He can’t cite any later because there weren’t any. Affordable housing goals go back to the 1930s and, in contemporary form to 1968-70. Again, those are really long policy lags. . . .

Finanical services remains one of the most highly regulated indsutries, perhaps second only to health care. Non-existent deregulation can’t explain the current crisis.

The policy change that occurred in the relevant time frame was the easing of monetary policy by the Greenspan Fed. From a high of 6.5% in May 2000, the Fed Funds rate was cut down to 2% in Nov. 2001 and remained there or below for 3 years. For one full year, it was at 1%. The real rate was negative for approx. 3 years. Negative real interest rates are inevitably inflationary, often causing asset bubbles.

Entry filed under: - Klein -, Bailout / Financial Crisis, Myths and Realities.

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3 Comments Add your own

1. Brian | 14 November 2008 at 10:59 pm

There surely was deregulation after 1999. The Commodities Futures Modernization Act of 2000 enshrined as a matter of federal law that interest rate and currency swaps received no federal oversight whatsoever, and that security-based swaps such as credit default swaps received only SEC oversight for fraud and market manipulation jurisdiction, but nothing else. It also did a host of other things, largely deregulatory in nature. It also repealed the long-standing prohibition on security futures, and created the so-called “Enron loophole” in the “exempt commercial market” where energy derivatives trade (the “loophole” was closed by the Farm Bill earlier this year).

Clinton signed it into law, BTW.
2. Peter Klein | 14 November 2008 at 11:30 pm

Brian, I’m not an expert on this legislation, but my understanding is that the CFMA mainly legitimized practices that were already widespread. The previous legislation governing derivatives, the 1936 Commodity Exchange Act, was already obsolete (because derivatives transactions were no longer passing through a single, centralized exchange). In short, the CFMA was not a significant piece of deregulation. Craig Pirrong has written about this, e.g.:

Click to access v25n2-6.pdf
3. Blissex | 15 November 2008 at 5:06 am

Using the idea that no new deregulation happened since 1999 is disingenuous, just as ignoring the negative real interest rate policy is.

The more plausible idea about regulation is that regulation and markets are bothy indispensable, and creating new markets without creating new regulation is dangerous. Even merely leaving existing regulation in place when markets grow a lot, because of cheap money, is dangerous. In any case not only regulation was insufficient in the face of new or expanding market activity, the *enforcement* of existing regulation was quite deliberately undermined for at least a decade.

The thesis is not that deregulation allowed market failures to happen, but *insufficient* regulation did, whether it was insufficient because regulation was removed or because regulation was not introduced where it should have been or increased with the size/scope of the market being regulated.

Also insufficient regulation allowed the flood of cheap money to impair the markets in financial payments and trade; if sufficient regulation had restrained those markets, the cheap money bubble would have resulted in seizures in the market for rare tulips or other markets much less critical to operation of the real economy.

As to negative real interest rates, they were part of a long-term trend of policies favouring asset-price inflation, presumably in the interest of vested asset owners, starting from what some think was the effective abolition of fractional reserve lending in 1995, which is the starting year of almost all trend changes I can see:

http://www.signallake.com/innovation/FedReserve1995.pdf
«The key event that happened around 1995 is that the fractional reserve ratio was not only lowered, it was effectively eliminated entirely. You read that right. The net result of changes during that period is that banks are not required to back assets which largely correspond to M3 or “broad money” with cash reserves. As a consequence, banks can effectively create money without limitation. I know that sounds hard to believe, but let’s look at the facts.»