---

Government Failure
...The U.S. government has heavily regulated the financial sector since the 1930s. (Banking has been under the government’s thumb at some level since the founding.) Yes, some regulations have been tweaked over the years. In 1999 — under Bill Clinton — the New Deal’s Glass-Steagall Act, which had separated investment and commercial banking, was repealed. But those regulatory changes were in response to specific problems caused by the regulations themselves. Separating commercial and investment banking was an arbitrary, artificial, and unnecessary decision by government officials, and it prevented banks from having the flexibility through diversification to better serve their customers in a competitive global economy. The changes were not part of any laissez-faire program, unless President Clinton was really a secret free-market advocate.

There was no general banking deregulation during the Bush years. On the contrary, the administration proposed to revamp regulatory oversight of the government-sponsored enterprises (GSEs) known as Fannie Mae and Freddie Mac, which were key agents in a decades-long effort to subsidize the housing industry by making it easy for low-income people with bad credit to get mortgages. These privileged corporations, by underwriting mortgages with an implicit government guarantee and selling bundles of them to investors around the world, put the financial system on shaky ground. In 2005 some Republicans tried to create an “independent” regulator to replace the one at the Department of Housing and Urban Development (HUD), but Republicans and Democrats who feared that that might rein in their beloved GSEs blocked the effort. Both sides were wrong. Fannie and Freddie did pose a threat to economic well-being — as we can see now — but new regulation wasn’t the answer. Abolition was. ...

...Moreover, as Cowen points out, it has been long-standing government policy to make it easier for non-creditworthy people to get mortgages: “legislation that has been on the books for years — like the Home Mortgage Disclosure Act and the Community Reinvestment Act — helped to encourage the proliferation of high-risk mortgage loans.” In fact, banks could be penalized for appearing to avoid lending money to people with poor prospects for repayment, that is, for “red-lining.” The passionate advocates of this social-welfare policy now call such bank loans “predatory lending” and condemn the banks for the practice. Damned if you lend, damned if you don’t.

For years government policy has encouraged and even required lax lending standards. As housing values increased, HUD made possible insured, no-money-down mortgages. In this environment banks did little income verification and would even lend more than 100 percent of the value of the home. What, them worry? Before the ink was dry, they would sell the dubious mortgages to Fannie, Freddie, or a bank operating in the secondary mortgage market created by the GSEs. The promise of a government bailout hovered overhead all along, destroying the natural market discipline that would have checked such recklessness. Nothing concentrates the business mind like the threat of bankruptcy. Remove that threat and, as Ayn Rand would say, it’s deuces wild. (A similar thing happened in the S&L collapse.) ...