In the 1,336 pages of the proposed Senate financial reform bill, the words “government sponsored enterprise” (GSE), “Fannie Mae,” “Freddie Mac,” and “subprime mortgage” appear a grand total of … not once.
Peter Wallison, general counsel of the Treasury Department under President Reagan, reminds us in his article “Fannie and Freddie Amnesia” in The Wall Street Journal of the $400 billion cost to taxpayers of putting those two GSEs into conservatorship.
The bill under consideration makes the assumptions that the markets failed, the financial services industry ran roughshod over the public in an unregulated environment, and that heavy federal regulation is the panacea. But it ignores the federal government’s extensive participation in the industry.
It was the Department of Housing and Urban Development that pushed Fannie and Freddie for “significantly increasing the GSEs’ affordable housing goals for the post-2000 period,” according to the Office of Policy Development and Research.
Receiving a favorable line of government credit and avoiding SEC scrutiny, these depression era vestiges (Fannie was launched in 1938) leveraged their balance sheets to as high as 75-to-1 while escaping market discipline.
They became the toxic-waste dump for subprime mortgages and the primary issuers of assets once considered so toxic that TARP was required: mortgage-backed securities that Wall Street sliced, diced, and spliced into derivatives with names out of a science fiction novel—“synthetic collateralized debt obligations hedged by credit default swaps.”
As investment banks disappeared in the crisis — with Goldman Sachs and Morgan Stanley fleeing to the protection of bank regulators and Fed supervision, and Bear Stearns and Merrill Lynch forced into absorption by commercial banks under the heavy hand of the Treasury Department and the Fed — industrial planning reached its ugliest. Every large bank now has a trading operation—internal hedge funds—that they view as more profitable than helping build American industry and communities.
Trading becomes easy, and too seductive, when banks can borrow at zero interest. It becomes incestuous when some banks, 19 to be specific, have a special relationship with the Fed as “Primary Dealers.” During the crisis, they were offered the exclusive Primary Dealer Credit Facility (that has since ended).
That these activities are not the intention of good monetary policy has escaped those politicians who at once rely on Wall Street money for campaign funds whilst they ironically bemoan Wall Street greed.
As reported in The Wall Street Journal, beneficiaries of these influence-buying contributions include lawmakers presently considering the proposed bill and the President, who received close to $1 million from employees of Goldman Sachs.
The “moral hazard” that the bill is purported to allay is made even more hazardous when there is a revolving door between big business and government. Thus there is an air of favoritism when Goldman is compensated fully for bad deals it made with state-run AIG. Such intercourse is vexatious not only because taxpayer funds are misallocated, but because the market—the best antidote to bad business decisions—is short-circuited by government.
Therein lays the counterpoint to the assumptions of financial reform bill. Let us therefore posit that less—far less—regulation is needed.
Let us then propose to keep the preamble to the bill: “To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes; Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled …” but replace the balance of the pages with “… the Federal government shall hereby divest itself of all activity in and control of the financial services industry and shall allow markets to work freely.”
Because, in the words of Nobel laureate F.A. Hayek, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”