Was it overregulation or deregulation that led to the Financial Crisis of 2007/08?

Hi
I just finished reading Niall Ferguson’s “The Great Degeneration”
In it he states the following about the financial crisis of 2007/08 :

“Those who believe this crisis was caused by deregulation have misunderstood the problem in more than one way. Not only was misconceived regulation as large part of the cause. There was also the feeling of impunity that came not from deregulation but from non-punishment” p. 75 “The Great Degeneration” by Niall Ferguson

“The failure to apply regulation -to apply the law-is one of the most troubling aspects of the years since 2007” p. 75 “The Great Degeneration” by Niall Ferguson

“A complex financial world will be made less fragile only by simplicity of regulation and strength of enforcement” p. 75 “The Great Degeneration” by Niall Ferguson

He argues that it was overregulation, not deregulation that caused the crisis. In 2007 and 2008/2009 I was following it closely. I remember so many articles and book blaming deregulation, especially of the Glass-Steagall Act which prohibited commercial banks from participating in the investment banking business, and the Community Reinvestment Act passed in the 1970s among others, but I wasn’t aware that the argument had shifted. What is the consensus now?

I look forward to your feedback.
davidmich

The consensus is still that underregulation was an important factor. Whether that consensus is correct or not is not a question for GQ.

I am not sure that the question really addresses the problems. I know it’s been used as a hobbyhorse by both factions, but the real issues seem, to me, to be caused by other forces than the level of regulation. There are certainly points where more regulation or control might have stopped some of the excess, but that’s secondary; I can’t think of a good case for “over regulation” causing any of the problems.

I would put the axis of problems squarely on an out-of-control housing market, and the cause on excessive reliance on “letting the market find its own level.” It did, eventually, but only after a wild swing in values that crushed millions of personal economies. Any time money is moving around that fast, financial sharks will find ways to take bites out of it that are not accessible or profitable in more stable times. (Ditto for the Enron mess a few years earlier.)

To answer your question, which I maintain is only a partial view of the real problem, I’d say under-regulation, coupled with significant under-enforcement of existing regs, were the cause.

ETA: In general, “overregulation” arguments tend to be used by those who would benefit from fewer restrictions on their activities, and they try to color that as “what’s good for GM” and all that.

His evidence for this thesis seems to be the fact that nobody has gone to prison as a result of the collapse. Make of that what you will.

G8 nation whose banking sector weathered the crisis with the least trouble: Canada
G8 nation whose banking sector was most heavily regulated: Canada

Just a single data point, admittedly.

Unbridled greed was the cause of the collapse more than anything else. The fact that significant numbers of bankers and stock brokers have not gone to jail or jumped from tall buildings from all of this only goes to shows that there wasn’t enough regulation. That is, what they did wasn’t illegal because there was no system of checks and balances being enforced that would have had repercussions on the perpetrators; i.e. lack of serious regulation.

G8 nation with relatively small banking sector and GDP: Canada
#notgq

Surely it was under regulation (or underenforcement) that allowed finance houses to package toxic debt into what looked like a good investment. This, coupled with a willingness to lend large sums to people who had little hope of repaying them, on the basis that house values would carry on increasing for ever, was the root cause of the crash.

Under-enforcing the pertinent rules, over-regulating aspects that might have helped “fix” things after the problems started, deletion of regulations that prevented profit for certain special interests,

Yeah, the rules were the problem, but there’s no single answer. The main problem, is that it’s money, and it’s a powerful corrupting force.

Some of the people who bought the bogus packaged debts were German institutions. Rumour has it that the more worldy-wise American and British financial cowboys who sold them this crap were amazed at how gullible they were.

Is that a problem of overregulation or underregulation? The German banks were naive because they were emerging from an overregulated system, and got completely taken up the a*** by the cowboys, who were better-versed in the ways of the financial jungle. But, arguably, wiser banks mean wiser lending, and wise lending is a good thing. A mature financial system will inevitably have cowboys. The Anglo-Saxon system knows this and deals with it. The newbies fell for it big time.

#notgq

The financial crisis was not a thing, but the culmination of many things all reaching a peak at the same time. The derivatives scandal was a separate problem from the housing bubble, e.g. Each had a multitude of causes as well.

Some people have argued that the financial deals got so complicated that nobody on any side - those creating them, those purchasing them, or those overseeing them - really understood what was happened. Even the rating agencies gave AAA ratings to deals that were absolutely rotten.

There are no simplistic solutions. If you call for more oversight, then you also have to fund the SEC, IRS, and other agencies to handle a heavier load and nobody is willing to do this. Certain laws might improve the underlying strength of banks but the bankers have shown that their real strength lies in creating new areas that are outside any lines. Punishing those guilty would help, but that means more money and people to pursue incredibly complicated multi-year cases. Overregulation provides incentives for people to find loopholes, just as it does in the tax code.

For the record, I don’t find Niall [pronounced Neal, BTW] Ferguson to be a useful source of information since he took over the Reliably Wrong column in Newsweek from George Will. If he says overregulation was the problem, then assume the opposite.

So you’re saying that his column entitled Reliably Wrong is reliably wrong?
I’m trying to work out if that logically means that Niall Ferguson is right.

You also have to remember that the core - not necessarily cause, but core - of the problem was millions of homeowners who fell for the multiple shucks about ever-rising home value. Stripping and spending equity, taking out loans far past their long-term ability to repay and in general falling for the “grab a bucket, it’s raining money” attitude is what fueled everything else.

For sharks to feed, there has to be something to feed on. That would be… us.

Yes, that’s a housing bubble. But there have been housing bubbles before. The question is, why was it so bad this time?
Personally, I like the generational theory, i.e. that this sort of thing happens every generation. That generation learns the lesson, and everything is relatively stable until about 30 years later when all the people who remember the mistakes are retired or dead. At which point the new generatrion makes exactly the same mistakes as the last one. So expect the next financial apocalypse in about 2040.

Whoosh. Reliably Wrong is my name for the predictable idiocy that filled that page.

I see. But “whoosh” implies that most people would get it, which I doubt.

I don’t know what adds to the thread but …
I recently talked to a mortgage broker and asked why the minimum credit score is now 640. He explained that banks sell off their mortgages to investors who now want a more security in their investment. The bank makes money off of servicing the loan rather than collecting the interest.

My first thought was, isn’t this how you got in trouble in the first place?

That may be at the base of it. I think the entire notion of “computer-based trading” was an accelerant - the banks and financial houses could do complex, fast-moving things not practical 20-30 years ago. Some of the derivatives trading was almost beyond human… if not comprehension, then capacity to manage without very powerful tools to help. Most Ponzi and pyramid schemes fly apart when the manager can no longer move fast enough to keep all the pieces in play. Computers and trading software let the process go on much longer than it might have otherwise.

I see deregulation and failing to apply regulations as related problems. GWB, in particular, accomplished much de facto deregulation with his appointments.

In addition to de-regulation, there is simple lack of regulation, with some practices escaping regulation because of their novelty. The huge unregulated financial derivatives market, where Wall Street companies were making multi-billion dollar bets, led to losses and instabilities which helped provoke the credit crisis.

IMO, the pervasive idealogy that Free Markets driven by Pure Greed have an almost mystical and unfailing power to solve problems and maximize value blinded many opinion makers and may have been as much a cause of the crisis as any specific deregulation.

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