Barack Obama and the Democratic majority in Congress need an economics lesson. Greed is not the deadly sin at the root of the current financial crisis.\u00a0 If anything, sloth is.\u00a0 And that means that loading a ton of new regulation on the already highly regulated financial sector will not prevent future crises.<\/p>\n
Populist Washington holds that the man behind the trading strategies at Wall Street houses is some latter day Gordon Gekko, a \u201cgreed is good\u201d I\u2019ve-got-mine swashbuckler. The truth is anything but. Try instead a guy with Coke bottle glasses tapping exotic programs into his laptop.\u00a0 He is a studious math whiz whom the boyhood Gekko would undoubtedly have taunted had they shared a grade school playground.\u00a0 If you want a portrait of the financial community\u2019s decision makers, don\u2019t rent the late-80s movie \u201cWall Street\u201d. Grab\u00a0 \u201cRevenge of the Nerds\u201d instead.<\/p>\n
The current financial crisis is rooted in innovations that were good in themselves, but later abused, mainly by politicians.\u00a0 In the early 80s, a series of regulatory reforms came out of Washington that opened the way to banks bundling mortgages and selling the packages (called derivatives) on the global capital markets.<\/p>\n
In developing these reforms Treasury and the other departments of government had to account for Wall Street\u2019s desire to control the risks inherent in mortgage loans. But at that time the risks were not so much of nonpayment as of early repayment.\u00a0 What the bond markets termed \u201ccall protection\u201d was not possible with mortgages.\u00a0 So, working with Wall Street, the regulators opened the door on instruments that allowed selling investors different levels of risk, the so-called traunching feature in mortgage-backed securities and similar financial instruments.<\/p>\n
The reforms worked splendidly.\u00a0 New money flowed into the mortgage markets \u2013 and soon into markets for consumer debt, commercial paper and a number of other uses.\u00a0 Home ownership for the middle class expanded.\u00a0 Other now fundable economic sectors grew.\u00a0 Investors received competitive returns.<\/p>\n
The financial instruments involved were, however, highly complex.\u00a0 Each was tailored to market conditions at the time of its initial sale.\u00a0 More and more elements were added as the years went on, including the default insurance that has now sunk underwriting giant AIG.<\/p>\n
With the success of this new (as some called it) \u201cfinancial technology\u201d, the major Wall Street players came to believe that they could quarantine risk and fund previously untouchable levels of uncertainty.\u00a0 In turn, the markets for the instruments involved became bewilderingly complex numbers games.\u00a0 Specialists understood the slivers of activity that they developed or traded. But, as has become clear in the past few weeks, few if any players fully understood the entire picture.<\/p>\n
As everyone now knows, in the 90s,Washington began to understand that Wall Street had revolutionized risk management and decided to get in on the act.\u00a0 Cheaper mortgages for the middle class were not enough, particularly to the Democrats in Congress, who formed the Congressional majority in the period this game flew out of control.\u00a0 What is the financial sector doing for the lower middle class and even the poor, they asked as they pushed for increasingly more risky mortgage lending.\u00a0 After all Fannie Mae and Freddie Mac would take care of defaults.<\/p>\n
Political pressure supplemented monetary ease.\u00a0 About five years ago, the Federal Reserve began a long-term campaign to keep interest rates at historic lows.\u00a0 Between the low rates and excessive confidence in their risk calibrating computer models, the financial community met Washington\u2019s demands and then exceeded them.<\/p>\n
Wall Street was working earnestly and hard, but in a key way it wasn\u2019t working hard enough. Neither were other global financial players, who participated in a global run up in housing prices. This is where sloth came in. No one was asking, what is the context?\u00a0 What are the assumptions underlying the so-called derivatives markets, particularly in housing?\u00a0 What are the weak points?\u00a0 Where are the vulnerabilities?<\/p>\n
The “No one” in this case was comprehensive.\u00a0 It included global financial trading and investment houses, global regulators and finance ministries, global insurers, the global financial media. No one.\u00a0 And why should we expect otherwise?\u00a0 All were looking at the same data.\u00a0 All used the same analytical tools?\u00a0 All were educated at the same schools.<\/p>\n
The failure was not unlike that of the tech bubble.\u00a0 In the late 90s the Fed loosened monetary policy, in part in anticipation of a Y2K meltdown.\u00a0 With Silicon Valley in overdrive, the venture capital community funded vast numbers of on-line ventures, not realizing that regulatory barriers absolutely prevented a build-out in Internet speeds and capacity at a pace that would allow most ventures to achieve viability in an acceptable timeframe if the financial environment changed.\u00a0 No one at any level appears to have asked about the interplay of political and monetary policy factors that might crash the dance and end it.<\/p>\n
But even if some players had understood the context and the factors that could stop the music, it might not have mattered.\u00a0 Plenty of people \u2013 from the Wall Street Journal editorial board to former Reagan White House counsel and American Enterprise Institute scholar Peter Wallison \u2013 have long warned of the coming insolvency of Fannie Mae and Freddie Mac. Congress brushed them aside. The media largely ignored them. To his credit, John McCain picked up on these warnings early — but not Barack Obama or any player in the now-so-vocal Democratic leadership.\u00a0 Why should we believe warnings in other areas of the current crisis would have brought different results?<\/p>\n
So this is the lesson to keep in mind.\u00a0 Whatever we do in adding regulations, the next crisis will come as a surprise to everyone, just as this one did, just as the burst of the tech bubble did. The fault here is not in twisted passions but limited vision.\u00a0 It is a human fault.\u00a0 Whether one works in financial houses or government agencies or the media, we are all subject to it.\u00a0 We all have been in the past.\u00a0 We all will continue to be in the future.<\/p>\n
Clark S. Judge is managing director of the White House Writers Group, a Washington-based policy and communications firm.\u00a0 He was a speechwriter to President Reagan<\/em><\/p>\n","protected":false},"excerpt":{"rendered":" Barack Obama and the Democratic majority in Congress need an economics lesson. Greed is not the deadly sin at the root of the current financial crisis.\u00a0 If anything, sloth is.\u00a0 And that means that loading a ton of new regulation on the already highly regulated financial sector will not prevent future crises. Populist Washington holds […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[33],"tags":[12],"class_list":["post-122","post","type-post","status-publish","format-standard","hentry","category-economic-policy-the-great-financial-crisis","tag-hugh-hewitt"],"aioseo_notices":[],"_links":{"self":[{"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/posts\/122","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/comments?post=122"}],"version-history":[{"count":4,"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/posts\/122\/revisions"}],"predecessor-version":[{"id":444,"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/posts\/122\/revisions\/444"}],"wp:attachment":[{"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/media?parent=122"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/categories?post=122"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.clarkjudge.org\/wordpress\/wp-json\/wp\/v2\/tags?post=122"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}