Vera Verba

I see a lot of stuff on the news these days about the failure of capitalism and lack of regulation causing the current financial crisis. My take on this is a bit different.

I found a very clear explanation of the current wall street financial crisis and bailout plan that I can find no fault with, so rather than going over this ground again, I will just direct you to the words of this author (who apparently has the LJ handle of “boffo”and is named “Nifty McNiftington” - and with a name like that, he better be good!) .

It is medium long, but worth reading in its entirety here: http://boffo.livejournal.com/770495.html

A couple key points that the author illuminates, and that is worth reiterating, are:

1.)  Insolvent banks are still insolvent under the bailout plan, and only banks that are having problems because of a short turn failure of credit markets will be saved. SO this bailout, in its conception, is not just giving money away (even if politicians might tend to bend it that way in its execution.)

2.) That it is this same short term credit market failure hurting these banks that is impacting the economy seriously, but that the government stepping in and affecting a bailout may actual prolong this crisis by keeping the market on hold, waiting for government evaluation of instruments that should have a free market valuation.

There are also a couple things this author doesn’t mention that I think are relevant:

A.) The banks involved are already strongly controlled and regulated to the degree that if I tried to go into the same business as they are in without extensive schooling on the legal issues and knowing a couple senators or some such so I could get the proper licensing, then I will be arrested for violating many different laws.

A truly free market could respond to a credit crunch by offering new players an opportunity to enter the market and make loans. But because these people would be arrested for violating banking laws, this does not happen. Regulation prevents the market from responding properly to the problem.

This is very similar to the situation we find ourselves in with the gas shortage in the South East.

We have a very large country with a great highway system, so how come gas can’t be trucked in from areas where there is a surplus to areas where they need it? the answer is that it is illegal. Government regulation divides the country into zones with different regulations on gasoline refining standards and additives. Gasoline approved for one part of the country is illegal to sell in another area.

B.) One of the reasons this problem of evaluating old loans in a downturn credit market has caused a downward spiral, is that new accounting regulations were imposed during the previous government bailout during the savings and loan crisis and again after the Enron failure.

Before these new regulations, the loans would have maintained their initial book valuation until they defaulted, were paid off,  or were sold. The new regulations require constant revaluation of loans on the books. Long existing regulations restrict a banks lending ability to a set percentage of its assets. So a downturn in the loan resale market both causes the bank to lose stock value and puts additional restrictions on banks lending ability.

Less availability of credit means more entities selling off both mortgage backed securities and bank stock when they need cash - further reducing the book value of banks and further tightening the credit crunch. Lather, rinse, and repeat until you have a complete credit market failure.

C.) Given that this crisis is in some part a result of the regulation added in reaction to previous problems, it seems quite likely that the new regulations (that will no doubt be added during this bailout) will also have unforeseen consequences.

***

This crisis is not the failure of a free market, but a failure of a market that is anything but free, adjusting to changes in regulation and ongoing government moderation. All of this happened in conjunction with a housing bubble with artificially low government set interest rates causing real estate to look artificially attractive to speculating investors, and two of the biggest lending entities (Fannie Mae and Freddie Mac) being pseudo government corporations run by people who “knew” that the government would step in and guarantee their failures and thus acted incautiously.

A lot of factors caused the current problems, but the last thing that it can be fairly called is a product of lack of regulation or failure of the free market. The motto on Wall Street has long been “Government compliance is Job One!”

This entry was posted on Saturday, October 4th, 2008 at 10:34 am and is filed under U.S. Politics. You can subscribe via RSS 2.0 feed to this post's comments. You can skip to the end and leave a response. Pinging is currently not allowed.