We Didn’t Deregulate
From the April 5, 2010, issue of NR.


Veronique de Rugy

When Barack Obama was running for president, he made no secret of his plan to “restore commonsense regulation” by closing up regulatory “loopholes” he blamed Republicans for opening. Deregulation of the financial industry, he argued, was a main cause of the financial crisis.

Much like Franklin Delano Roosevelt during the Great Depression, President Obama offered a sweeping, ambitious regulatory agenda: a total revamp of the financial industry, including reform of the process by which loans are converted into securities; more robust federal regulation of credit-rating agencies; the creation of a systemic-risk regulator; stricter government oversight of the hedge-fund industry; new regulation of credit-default swaps; and the consolidation of several financial regulatory agencies.

But unlike FDR, Obama won’t have to create a new regulatory system from scratch: For all the lamentation of our allegedly scanty policing of Wall Street, the financial industry already answers to a host of regulators, including the Federal Housing Finance Agency, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and, not least, the Securities and Exchange Commission.

In fact, as Peter J. Wallison of the American Enterprise Institute explained in 2008, “almost all financial legislation, such as the Federal Deposit Insurance Corp. Improvement Act of 1991, adopted after the savings and loan collapse in the late 1980s, significantly tightened the regulation of banks.” In other words, we’ve had regulation, not deregulation.

The great villain in the deregulation myth is the Gramm-Leach-Bliley Act, signed into law by Bill Clinton in 1999, which repealed some restrictions of the Depression-era Glass-Steagall Act, namely those preventing bank holding companies from owning other kinds of financial firms. Critics charge that Gramm-Leach-Bliley broke down the walls between banks and other kinds of financial institutions, thereby allowing enormous systemic risk to percolate through the financial world. This critique is the keystone of the “blame deregulation” case, but it doesn’t hold up: While Gramm-Leach-Bliley did facilitate a number of mergers and the general consolidation of the financial-services industry, it did not eliminate restrictions on traditional depository banks’ securities activities. In any case, it was investment banks, such as Lehman Brothers, that were at the center of the crisis, and they would have been able to make the same bad investments if Gramm-Leach-Bliley had never been passed.

Another common claim, that credit-default swaps and other derivatives left unregulated by the Commodity Futures Modernization Act of 2000 were a cause of the financial crisis, doesn’t stand up to scrutiny, either. Research by Houman Shadab of the Mercatus Center has shown that this argument is undermined by its failure to distinguish between credit-default swaps, which are simply insurance against loan defaults, and the actual bad loans and mortgage-backed securities at the root of the crisis. Stricter regulation of credit-default swaps wasn’t going to make those subprime mortgages any less likely to go bad.

And it’s not as though our regulators have been hamstrung by a lack of resources. Government budget figures show that inflation-adjusted spending on finance-and-banking regulation has gone up significantly over the last 50 years, from $190 million in 1960 to $2.3 billion in fiscal 2010. Total real expenditures for finance-and-banking regulation rose 45.5 percent from 1990 to 2010, with a 20 percent increase in the last ten years. That spending rose by 26 percent during the Bush years, and by 7.1 percent in 2009. While these data do not say anything about the regulators’ effectiveness, it is reasonable to assume that a dramatic increase in their budgets is not a sign of radical deregulation.