“Feeding the Wolves”

Can regulatory reform fortify the economy, without addressing problematic federal policy?

           

In the wake of the worst financial down turn since the Great Depression, America looks to Congress to rebuild. And rebuild it does with the most extensive recovery and regulatory legislation since 1930’s. But after decades of encouraging “big, bad” Wall Street to blow the economy down, can Congress get it right this time?

Two columns published in the Wall Street Journal raised questions about the validity and effectiveness of government forays into free market regulation. In Monday’s column, “Basel’s Capital Illusions,” George Melloan approved of “holding banks to higher capital standards,” but argued “lax regulation,” of the financial industry in the U.S. was not the cause of the financial meltdown. Rather, he credits a combination of federal affordable housing efforts and actions by the Federal Reserve driving excessive demand in the housing market. Neither of these activities is regulated under the new Basel standards or July’s Dodd-Frank legislation.

In a 2008 column appearing in the Wall Street Journal, author Robert Russell also argues several mistakes by the federal government helped drive housing prices up to unsustainable high levels. By 2005, HUD was pushing Fannie Mae and Freddie Mac to extend 22 percent of their mortgages to people with incomes less than 60 percent of a region’s median income. At the same time, President George W. Bush was promoting his initiative to create a wider base of home ownership amongst low-income individuals, by offering down payment assistance. In addition, a low Federal Funds Rate gave people the ability to take advantage of low interest rates and borrow more money.

Expanding the base of demand while lowering the cost of borrowing can only drive prices up, by giving more consumers more money to compete in a seller’s market. In addition, the drive to push low-income individuals, particularly ones without a financial safety net, into home ownership is quite a gamble.

Though deregulation has caught much criticism, the regulations repealed don’t pertain to the government activities that helped drive the housing market. In addition, Melloan notes Fannie Mae and Freddie Mac are exempt from both Dodd-Frank and Basel, despite the fact both were responsible for packaging mortgage backed securities.    

Overall, the federal government seems happy to blame Wall Street for the crisis, and create legislation which overlooks two formerly problematic government institutions and several poor federal policies.

The question is do we want to the government more control through legislation that falls short of addressing it’s own flaws?

 Coming up… “The pigs have won tonight…” Will financial reform go to far?