Monday, September 22, 2008

Meltdown - Regulations

Many writers have blamed the current financial crisis on too little regulation of the market. In particular, they have blamed the 1999 repeal of the Glass-Steagall Act that was enacted in 1933 in the midst of another financial meltdown. That Act created, among other things, a wall between investment and commercial banking. It is claimed that the Act's repeal allowed for the creation of “mega-banks” which, we are led to believe, precipitated the current crisis.

However, what we have seen thus far is the failure of two government-sponsored mortgage institutions (Fannie Mae and Freddie Mac), an insurance company (AIG), and two investment houses (Bear Stearns and Lehman Bros.) - none of which would have fallen under the Glass-Steagall regulations. In fact, those companies that have both investment and commercial banking operations are so far weathering the current storm.

Megan McArdle has some thoughts on Glass-Steagall as well.

Tyler Cowen also examines the idea that there was too little regulation. In fact, he says, the regulation was just ineffective.
[F]inancial regulation has produced a lot of laws and a lot of spending but poor priorities and little success in using the most important laws to head off a disaster. The pattern is reminiscent of how legislators often seem more interested in building new highways — which are highly visible projects — than in maintaining old ones.
He also sends a warning about rushing into creating new regulations:
[I]f you hear a call for more regulation, without a clear explanation of why regulation failed in the past, beware. The odds are that we’ll get additional regulation but with even less accountability and even less focus on solving our very real economic problems.

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