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InsiderOnline Blog: October 2008

The Culprit Is Government, Not Deregulation

In his latest column, Sebastian Mallaby debunks the storyline that a lack of government oversight has caused the current financial crisis. What really happened, he argues, is that “the Fed’s track record of cutting interest rates to clear up previous bubbles” led financial engineers to believe that they could profit in good times and be bailed out by the Fed when things went bad—all in all, a classic case of moral hazard created by the government.

What’s more, he points out, the folks who binged on mortgage-backed assets were in fact heavily regulated:

U.S. investment banks, regulated by the Securities and Exchange Commission, bought piles of toxic waste. U.S. commercial banks, regulated by several agencies, including the Fed, also devoured large quantities. European banks, which faced a different and supposedly more up-to-date supervisory scheme, turn out to have been just as rash. By contrast, lightly regulated hedge funds resisted buying toxic waste for the most part – though they are now vulnerable to the broader credit crunch because they operate with borrowed money.

Of course, another little confounding detail is that the highly-regulated Fannie Mae and Freddie Mac “bought more than a third of the $3 trillion in junk mortgages created during the bubble” because “heavy government oversight obliged them to push money toward marginal home purchasers.”

Posted on 10/07/08 11:53 AM by Alex Adrianson

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