Last week I spoke about a working paper, published by the International Monetary Fund this past January, which provides empirical support for the idea that large-scale deregulation generates a financial crisis.
Brilliantly prepared by Jihad Dagher, Regulatory Cycles, Revisiting the Political Economy of Financial Crisis, is a thorough, well documented exploration of boom and bust cycles worldwide over the last 300 years, with an emphasis on regulations in banks and other credit issuing institutions.
He thoroughly examines the political economy of financial policy during ten of the most infamous financial booms and busts since the 18th century. What is an obvious premise (or should be) is his consistent evidence of pro-cyclical regulatory policies by government.
Mr. Dagher offers a quote that is worth more consideration: The economic role of the state has managed to hold the attention of scholars for over two centuries without arousing their curiosity. George Stigler, 1964.
Let’s also add bankers and politicians.
The paper clearly points out, “that episodes of financial boom went hand in hand with a period of significant deregulation. These episodes were generally accompanied, and sometimes triggered, by procyclical policies by governments that actively amplified credit booms, weakened existing financial regulations and supervision, and engaged in regulatory forbearance… When spectacular booms came to an end, the ensuing crises led to major reforms and reversal of earlier policies.”
He goes on to say, “While in most cases the incumbent governments championed laissez-faire policies, they nevertheless engaged in subsidization of credit and intensification of symbiotic relations with bankers and large companies.”
And so we need to ask ourselves why we are amazed at the constant repetition, as this pro-cyclical evidence is right under our nose. In boom times we go all out, get rid of restrictions and regulations and encourage all kinds of risk in our financial institutions, which is clearly aided and abetted by our politicians, who enable banks to take risks so they can gain from their campaign contributions. Then comes the inevitable bust and we again start imposing ever more stringent rules so it doesn’t happen again. Surprised once again!
We often point fingers for financial meltdowns on the irresponsible traders and greedy bankers, however as Mr. Dagher suggests, perhaps we need to more closely look at the “politicians whose policies sometimes fan the flames.”
Mr. Dagher claims “the regulatory backlash that ensues from financial crisis can only be understood in the context of the deep political ramifications of this crisis.” A suggestion of his, which seems rather obvious, yet we ignore at our own peril is “whether a strong level of governance and institutions that are less prone to private interests could help mitigate these ex-post inefficient regulatory cycles?”
The problem is a symbiotic one, each feeding on the greed and malfeasance or unawareness of the other. He’s right; politicians fan the flames and deserve scrutiny as well.
As Mr. Dagher states “history suggests that politics can be the undoing of macro-prudential regulations”… He notes, “It is the same type of lending that the government sponsored, the very financial instruments that it de-regulated, that contributed to creating the perfect storm that later resulted in the regulatory backlash.”
We are certainly seeing this with the relaxing of Dodd-Frank, with the administration actually admitting “we’re doing a real number on it.”
Will any of Dodd-Frank’s stricter standards survive? If history is any guide, Dagher says probably not. So down with another safeguard, cumbersome as it may have been.
I found it interesting to learn from Mr. Dagher that prior to 1900, National banks were not permitted to underwrite, deal or invest in securities, nor could they originate real estate mortgages. Yet as the economy expanded, many of these restrictions were removed to encourage more of the boom. Then came the crash of 1929 which subsequently saw a change in political parties and a series of radical reforms re-regulating mortgages and securities (remember Glass-Steagall?).
Then fast-forward to the expanding economy of the 70’s through 90’s with the loosening of the regulations on mortgages (the CRA, affordable housing, etc) and repeal of Glass-Steagall.
There is a reason we have regulations and some restrictions. It’s clear from the staggering amount of study that has been done, not just on Mr. Dagher’s part, but others he references throughout the paper that “rolling back regulations comes before a financial meltdown.”
Yet while some clearly see this and point it out, it is virtually ignored. Government gleefully ignores the facts and leads us down another path to financial disaster, then chides, fines, and again picks up the pieces when it all falls apart.
Is this enabling greed, cronyism or sheer stupidity? Mr. Dagher makes repeated observations that the deregulation phase is when the special interests seemingly have the most influence, if not control, of the political process. The revolving door we have where bankers and lawyers leave lucrative positions for government, and are assured of yet another lucrative corporate position, is ludicrous and dangerous to our economic well-being.
What are we missing here? And when will we hold politicians and government, not just bankers and investors, accountable?