First Lady Michelle Obama was on the hustings yesterday, touting her husband’s handling of the economy. But while the unemployment rate is trending downward, significant problems remain. This is probably not the time to declare “mission accomplished.”
Conservatives, of course, will point to the budget deficit and the need for entitlement reform, but there’s another — less ideologically divisive — point worth making: Almost none of the fundamental structural problems that led to the Great Recession have been fixed.
In fairness, few things are more controversial than the debate over exactly what caused our current crisis. Andrew W. Lo, for example, read 21 books on the subject, and ultimately concluded that: “No single narrative emerges from this broad and often contradictory collection of interpretations…” It would be an understatement to describe this as nebulous. (The only thing I’m absolutely certain of is that — despite the amount of ink spilled — neither “income inequality” nor the war in Iraq were the primary drivers.)
But at the risk of sounding overly-simplistic, here are five (mostly un-sexy) governmental policies which probably led to the financial disaster:
1. The FED kept interest rates too low for too long – This isn’t rocket science. Keeping interest rates artificially low led predictably to excessive credit and speculative asset bubbles — such as occurred in the housing market (this problem has not been fixed).
2. The expanded mandate of Fannie and Freddie - The housing collapse can very likely be traced back the Clinton administration’s pressuring of Fannie and Freddie to encourage more home buying. The Community Reinvestment Act, for example — in which banks were encouraged to people who normally would not be worthy of obtaining home loans — was especially pernicious. The CRA, of course, had been around for a long time prior to Clinton, but as Howard Husock noted in 2000, the Clinton Administration, “turned the Community Reinvestment Act, a once-obscure and lightly enforced banking regulation law, into one of the most powerful mandates shaping American cities.”
(Note: Anyone interested in learning more about Fannie and Freddie should read “Reckless Endangerment,” by Pulitzer Prize-winning business reporter and New York Times columnist Gretchen Morgenson, and housing finance expert Joshua Rosner.)
3. Mark-to-market accounting – This accounting device requires financial institutions to adjust their balance sheets and capital accounts whenever the value of an asset they own increases or decreases. The trouble with this is that it requires banks to show paper losses for assets they may have no plans to sell (in fact, the bank may be planning to wait for the price to increase prior to selling it). FDR suspended mark to market accounting in 1938, but unfortunately, the George W. Bush administration brought it back in 2007. As Steve Forbes wrote in 2009: “Of the more than $700 billion that financial institutions have written off, almost all of it has been book write-downs, not actual cash losses.” (The requirement has since been loosened.)
4. Repeal of the uptick rule – Also enacted by FDR, the uptick rule says investors can’t short a stock unless it goes up in price. According to Investopedia: ”The uptick rule prevents short sellers from adding to the downward momentum when the price of an asset is already experiencing sharp declines.” In 2007, the SEC got rid of the rule, resulting in investors betting against the market, manipulating the market, and depressing stock prices. (Note: Like everything else on the list, some people dispute the notion that the uptick rule would have helped. Others argue that short sellers get a bum rap. For example, the last infamous CEO to complain about short sellers was Dick Fuld of Lehman Brothers. The company went bankrupt and short selling had nothing to do with the rapid decline of price.)
5. Repeal of Glass-Steagall – Enacted by FDR after the Great Depression, a main provision of Glass-Steagall was seperating investment banking from commercial banking. But in 1999, the Gramm–Leach–Bliley Act (passed by a majority of Republicans and signed by Bill Clinton) repealed that provision. The problem, of course, is that this encouraged banks to be speculative — to take risks, knowing all along that the FDIC would insure their loss. (The notion that repealing Glass-Steagall contributed to the recession is disputed by some economists. Some would even argue that it helped. For example, when Bear Stearns and Merrill Lynch got into serious trouble, they were promptly acquired by J.P. Morgan and Bank of America. These rescues were possible only because banks could own full-service broker-dealers.)
So there you have it: Five things which (I, at least believe) contributed to the crisis.
This list specifically focused on things which the government, in some way or another, was responsible. But it’s also worth noting that the creation and rapid expansion of new financial instruments (such as credit default obligations and credit default swaps) certainly contributed to the financial crisis (of course, government did not step in to regulate or ban them — and still hasn’t).
It’s also worth noting that these problems were collectively created in a bipartisan fashion — with mistakes being pretty evenly divided between the Clinton and Bush administrations.
What is more, most of the primary contributors to the Great Recession are still in place. Fed rates are near zero. Banks are still Too Big To Fail — Dodd-Frank certainly didn’t end that. Very little has been fixed.
And there is little reason to believe any of these underlying issues will soon be addressed. Most of today’s hot-button campaign issues (think income inequality, abortion, contraception, etc.) don’t come close to addressing any of the fundamental problems.
Perhaps this would be something for President Obama and Congress to look into?