Regulation and the financial crisis

No sooner had the first tremors of the financial crisis begun to emanate across the country than many Democrats had already found their villian: deregulation. Foremost among those those feeding this mantra was Barack Obama, who stated during the second debate:

Let's, first of all, understand that the biggest problem in this whole process was the deregulation of the financial system.

This, however, is patently untrue. The only notable deregulation of Wall Street that occurred in the last 10 years was the 1999 Gramm-Leach-Bliley Act that allowed commercial and investment banks to consolidate. There is little evidence, however, that this contributed to the financial crisis as noted by factcheck.org:

The truth is, however, the Gramm-Leach-Bliley Act had little if anything to do with the current crisis. In fact, economists on both sides of the political spectrum have suggested that the act has probably made the crisis less severe than it might otherwise have been.

Recently it seems that the story has shifted, as evidenced by this recent New York Times interview with President Obama:

Are there tangible ways that Wall Street has made the average person’s life better in the way that Silicon Valley has?

THE PRESIDENT: Well, I think that some of the democratization of finance is actually beneficial if properly regulated. So the fact that large numbers of people could participate in the equity markets in ways that they could not previously — and for much lower costs than they used to be able to participate — I think is important.

Now, the fact that we had such poor regulation means — in some of these markets, particularly around the securitized mortgages — means that the pain has been democratized as well. And that’s a problem. But I think that overall there are ways in which people have been able to participate in our stock markets and our financial markets that are potentially healthy. Again, what you have to have, though, is an updating of the regulatory regimes comparable to what we did in the 1930s, when there were rules that were put in place that gave investors a little more assurance that they knew what they were buying.

Now Obama has changed his stance from blaming deregulation to "poor regulation." This is an important difference. Rather than citing a lack of regulation, the argument is now that the right type of regulation wasn't in place.

Also seeming to advance this meme is prominent leftist Robert Kuttner:

[Kuttner] pinned the problem on “regulatory competition,” the fact that financial institutions could “venue-shop” among the Securities and Exchange Commission, the Office of the Comptroller of the Currency and other federal and even state-level regulatory agencies, presumably to find an overseer with lenient proclivities.

Later Mr. Kuttner noted a point of difference. This was not a “regulatory failure,” he said, but a “regulatory corruption.” He blamed Senator Charles E. Schumer, former Treasury Secretaries Robert Rubin and Lawrence Summers and other officials for “being complicit in regulations that allowed credit default swaps.”

“Regulators,” Mr. Kuttner said, “are a creature of the political process.”

It's interesting how Kuttner can simultaneously get this right and dreadfully wrong. He is correct that regulators are a creature of the political process. But he also tries to cast blame on individuals, singling out Schumer, Rubin and Summers, with the implication being that if we just had the right people in place that everything would have worked out.

This is wrong. After all, politics is corruptible. Regulators, as Kuttner admits, are creatures of the political process. Therefore they are corruptible.

Obama and Kuttner are both laboring under the impression that if they can just get the correct mix of individuals and rules correct that everything will work out, that tinkering at the margins is all that is needed. What they fail to realize is that it is the very system they advocate that is flawed.