Marketplace of Ideas Blog

FirstTrust Advisors’ Brian S. Wesbury and Robert Stein on whether or not the past recession demonstrates the need to reregulate the financial industry:

The banking crisis of the early 1980s — also largely created by easy Fed policy — had more loan losses than existed at the beginning of the crisis of 2007–2008. Adding the early ’80s bad debts in agriculture, oil, and Latin America to those of the Savings & Loan Industry created bank losses of roughly 6% of GDP. Sub-prime and Alt-A loan losses in 2007 were roughly 4% of GDP. But once mark-to-market accounting started to accelerate, even those smaller losses, undermined confidence and created a vicious feedback loop which put the system in jeopardy. While some argue that it is TBTF [Too Big to Fail] institutions that create systemic risk, in reality it is misapplied government action and policy which creates this risk.

Government action and reaction is why a large (but non-lethal) set of banking losses, spread so rapidly and turned into the Panic of 2008.

Instead of suspending mark-to-market accounting rules in 2008, the Fed, Treasury, SEC, and FDIC arbitrarily saved certain firms while allowing others to fail. The crisis accelerated after Lehman Brothers failed, which then led to more government bailouts. Instead of allowing banks to value loans using cash-flow, the government forced these loans to be priced to illiquid market prices. When this put institutions in technical violation of arbitrary capital requirements, Treasury Secretary Hank Paulson forced these banks to swallow TARP money and accept government ownership. …

It was government that caused the Panic of 2008, not the private financial system. If government had not artificially boosted housing in the first place, had run a stable monetary policy, and did not enforce a dumb accounting rule, the Panic of 2008 would not have happened.