24 September 2008

Gramm-Leach-Bliley caused all this? Okay, but how?

[B]iology tells us that a high degree of habitual well-being is not advantageous to a living organism. Today, well-being in the life of Western society has begun to take off its pernicious mask. -- Alexander I. Solzhenitsyn, “A World Split Apart” (1978)

The question is how, exactly, a law allowing commercial and investment banks to consolidate caused all this.

While the media have been relatively quiet about Democrats who worked for or received money from Fannie Mae or Freddie Mac, they apparently could not contain themselves when they stumbled across this bit of news:

One of the giant mortgage companies at the heart of the credit crisis paid $15,000 a month to a firm owned by Senator John McCain’s campaign manager from the end of 2005 through last month, according to two people with direct knowledge of the arrangement. The disclosure contradicts a statement Sunday night by Mr. McCain that the campaign manager, Rick Davis, had no involvement with the company for the last several years. Mr. Davis’s firm received the payments from the company, Freddie Mac, until it was taken over by the government this month along with Fannie Mae, the other big mortgage lender whose deteriorating finances helped precipitate the cascading problems on Wall Street, the people said.
By my math that amounts to less than $500K for the whole period. Well, that cinches it: Republicans are complicit in this mess after all. We all knew that; it was just a matter of finding the facts to fit the thesis.

In a real bit of journalism, Charles W. Calomiris and Peter J. Wallison explain why Fannie Mae and Congress are to blame. Frankly I find their case stronger because it doesn’t involve some insinuation of complicity by virtue of monies received:

In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of "affordable housing." They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them.


In light of the collapse of Fannie and Freddie, both John McCain and Barack Obama now criticize the risk-tolerant regulatory regime that produced the current crisis. But Sen. McCain's criticisms are at least credible, since he has been pointing to systemic risks in the mortgage market and trying to do something about them for years. In contrast, Sen. Obama's conversion as a financial reformer marks a reversal from his actions in previous years, when he did nothing to disturb the status quo. The first head of Mr. Obama's vice-presidential search committee, Jim Johnson, a former chairman of Fannie Mae, was the one who announced Fannie's original affordable-housing program in 1991 -- just as Congress was taking up the first GSE regulatory legislation.

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, introduced by Republican Sens. Elizabeth Dole, John Sununu and Chuck Hagel, and supported by then chairman Richard Shelby. The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent. (Emphases mine.)

As the fever to pin this entire mess on Republicans by way of Gramm-Leach-Bliley (which, in Senator Obama’s words, constituted the “de-regulatory steps that helped cause this mess") continues to burn, we can thank the New York Sun for digging up responses of Democrats like Charles Schumer to this legislation:

If we didn't pass this bill, we could find London or Frankfurt or years down the road Shanghai becoming the financial capital of the world. That has grave implications for all of America, where financial services are one of the areas where jobs are growing the most quickly, where our technology is way ahead of everyone else, where our capital dominates the world. And it would be a shame if because Congress has been unable to act that all those advantages were frittered away as they well could be in a global world by our failure to realize the problems that our existing antiquated laws cause us.

Gramm-Leach-Bliley repealed much of the Glass-Steagal Act, something for which those of us in any way connected or interested in finance were waiting a long time. (My connection and interest amounts to this: I was raised by business people. These matters were often the topic of dinner conversation.) And Schumer is right: he and others worked on Gramm-Leach-Bliley for around 18 years. Indeed I recall a conversation with an acquaintance of mine around 1988. I can no longer recall what I said, but it elicited this response: “You wait till they repeal Glass-Steagal. That’ll all change.” (Yes, I really have conversations like that in real life.)

President Clinton called Gramm-Leach-Bliley “a major achievement that will benefit American consumers, communities, and businesses of all sizes." (On that note, here’s a 13 November 1999 New York Times story about President Clinton signing Gramm-Leach-Bliley into law.) If conspiracy theorists can believe that the Bush administration orchestrated the 911 attacks, perhaps they can swallow a gnat such as that Democrats engineered this whole mess, beginning with Gramm-Leach-Bliley (which, you’ll recall, Senator Obama has identified as the epicenter of this quake) because they don’t like capitalism. After all, it is kind of funny that Democrat talking points sound an awful lot like communist talking points. (It doesn’t surprise us former socialists.)

One thing I don’t understand is this. The Left love to emulate Europe. As Rich Lowry points out here, when Gramm-Leach-Bliley was passed, Europe already had similar laws allowing financial institutions to engage in a wide array of ventures. Indeed, one of the purposes of Gramm-Leach-Bliley was to give us opportunity to compete with Europe. Now many of the same Democrats who sought passage of the act, blame the act for our present malaise.

Now, it may be that Gramm-Leach-Bliley is the cause. But that’s all we’re being told. What’s missing is the explanation of how Gramm-Leach-Bliley caused these problems. It’s one thing to say Gramm-Leach-Bliley causes all this; it’s another to explain how Gramm-Leach-Bliley caused this. Supposedly, Gramm-Leach-Bliley was an instant of “deregulation”. Fine. But how did this putative deregulation cause anything? Or, to put it better: What (if anything!) was formerly prohibited under Glass-Steagal, and now permitted under Gramm-Leach-Bliley, which would have prevented the present mess?

Politicians, when assigning blame are very good about employing generalizations and abstractions. Bush’s “failed” economic policies, in the form of “deregulation” under Gramm-Leach-Bliley are to blame. It sounds meaningful; but it isn’t. Gramm-Leach-Bliley caused all this. That sounds meaningful also; but most of the people listening have no idea what Gramm-Leach-Bliley is, much less what Glass-Steagal was. What’s needed here is not abstraction but concreteness.

Again, the question is: How, exactly, did a law allowing commercial and investment banks to consolidate cause all this mess?


Peter L. Griffiths said...

The answer is I think that Gramm-Leach-Bliley in 1999 enabled the American banks to under-cut Fannie Mae and Freddie Mac in offering services such as securitization. The 2007-2008 financial crisis was a crisis of defaulting debtors originating from credit default swaps as well as from the inability of Fannie Mae and Freddie Mac to honour their guarantee obligations, made worse by the loss of business inflicted by Gramm-Leach-Bliley.

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James Frank SolĂ­s
Former soldier (USA). Graduate-level educated. Married 26 years. Texas ex-patriate. Ruling elder in the Presbyterian Church in America.
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