September 25, 2022

Eager to Regulate, Some Economists Reject Reality

Nouriel Roubini, a professor at the Stern Business School at New York University, says that the current fiscal crisis was caused by the failure of “the laissez-faire, unregulated (or aggressively deregulated), Wild West model of free market capitalism” and that nationalization of financial institutions and heavy regulation is a requirement of a stable economy.

Evidently Roubini is willing to overlook the two primary causes of the home mortgage debacle that has now spilled over to the economy at large:

  • The aggressive regulation forced on Fannie Mae and Freddie Mac by the the Clinton housing bill that forced quotas on the lending institutions, essentially forcing them to take on risk far in excess of what the free market would have allowed.
  • The greedy, grasping indulgence of American borrowers who, knowing full well that their means was insufficient to cover even the slightest increase in historically low interest rates, took advantage of federally mandated “access” to home mortgages that they had no hope of repaying.

That doesn’t sound like Wild West capitalism to me; rather, it sounds exactly like what one would expect from a market distorted and ultimately destroyed by governmental regulation.

Phil Gramm says:

By the time the housing market collapsed, Fannie and Freddie faced three quotas. The first was for mortgages to individuals with below-average income, set at 56% of their overall mortgage holdings. The second targeted families with incomes at or below 60% of area median income, set at 27% of their holdings. The third targeted geographic areas deemed to be underserved, set at 35%.

The results? In 1994, 4.5% of the mortgage market was subprime and 31% of those subprime loans were securitized. By 2006, 20.1% of the entire mortgage market was subprime and 81% of those loans were securitized. The Congressional Budget Office now estimates that GSE losses will cost $240 billion in fiscal year 2009. If this crisis proves nothing else, it proves you cannot help people by lending them more money than they can pay back.

Gramm’s last point is dead on target.  The lesson that should be learned from the home mortgage crisis is that governments should stay the hell out of markets they either don’t understand or don’t care if they ruin. 

The liberal notion that unqualified home buyers “deserve” to own their own houses is the root cause of the mortgage market’s implosion.  It may be that additional regulation is required to steer the world economy out of the straits that government bungling took us into; however, that doesn’t change the fact that it’s misguided, anti-market policies that put us in danger in the first place.

Roubini does make one excellent point:

This crisis also shows the failure of ideas such as the one that securitization will reduce systemic risk rather than actually increase it. That risk can be properly priced when the opacity and lack of transparency of financial firms and new instruments leads to unpriceable uncertainty rather than priceable risk.

That’s exactly right.  The financial industry was allowed to obfuscate the value – or lack thereof – of their loan portfolios by slicing, dicing, and rearranging their portfolios beyond recognition.  This should never have been allowed.  As Roubini says, “It was not that regulators were not empowered; it was that they were not alarmed.”  Or not interested during the Bush administration’s reign.

The proper amount of regulation, contrary to Roubini’s thesis is simply this: just enough to keep the players in the game honest.  In this case there were too many cheaters, in government, on Wall Street, and on Main Street.


Marc is a software developer, writer, and part-time political know-it-all who currently resides in Texas in the good ol' U.S.A.

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