The Financial Crisis and the Failure of Regulation

Sebastian Mallaby of the WaPo chides Obama for blaming the current financial crisis on a Republican failure of regulation. But Mallaby misses the main cause of the crisis — Republican Ayn Rand ideology in the person of Alan Greenspan, who rejected pleas by Fed Governor Ed Gramlich among others to tighten up on sub-prime lending as early as 2001.

Sebastian Mallaby of the WaPo challenges Obama’s attribution of the financial crisis to Republican under-regulation.

Though some of his points are interesting as second-order issues, he misses the main event.

The most important regulatory contribution to the current crisis was Alan Greenspan’s deliberate refusal to move to tighten up regulation of the sub-prime mortgage market. Edward Gramlich, a Fed governor, urged this action as early as 2001 and Greenspan refused. Greenspan is a life-long Republican and devotee of the Ayn Rand anti-government philosophy.

So Obama is completely correct to blame the current crisis on a Republican ideological allergy to regulation. The Phil Gramm connection with the McCain campaign and McCain’s own statements just serve to tie a McCain presidency into the broader theme.

Update See the Post’s page 1 treatment of McCain’s record on regulation in general.

Update 2 A reader urges that I acknowledge the substantial Democratic support for the repeal of Glass-Steagall in 1999– driven, he suggests, by campaign contributions from financial institutions to key members of Congress. Glass-Steagall repeal was important in the current crisis, in that it created new competitors to investment banks and thus probably reduced the level of prudence all around. (I think but am not sure that AIG could not have gotten into trouble if the 1999 repeal hadn’t happened, but that the sub-prime crisis itself was not affected by Glass-Steagall.)

However, the chance to regulate the emerging collateralized debt and credit default swap markets would still have been there but for Phil Gramm’s end-of-session Commodities Futures legislation in December 2000. Most likely the Bush administration would have refused to use these powers even had the Gramm legislation not taken them away. Paul Volcker, who was the last Democratic appointment as Chairman of the Fed, has been calling for regulation of derivatives and other complex financial instruments for the last decade. So there is a clear case that the Republicans are more to blame than the Democrats.

But my reader urges that if Democratic complicity is not recognized then the remedy may not go as far as needed. Fortunately Obama’s campaign positions on lobbyist involvement and his demonstration of a new, broader-based model for funding Democratic campaigns, along with his support for campaign finance reform, offer hope of reducing this blockage to re-regulation, should it in fact be significance. My own belief is that the current disaster and the recession that will shortly become evident will overcome any corrupting influence of campaign cash for the next year.