New School Politics

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Not unexpectedly, there has been a sufficient amount of crowing from the left about the need for more financial regulation in light of the credit crunch. Their reasoning seems to encompass little more than the idea that deregulation or underregulation was the source of our current problems (which makes even less sense when you consider that there is no significant repeal in mortgage or lending laws to my knowlege).

This essay, however, directly refutes that idea:

The most striking fact about the ongoing financial mayhem is that it is concentrated not in lightly regulated hedge funds but in more heavily regulated commercial and investment banks. It is banks that created subprime mortgage securities. It is banks that mispriced them. And it is banks that filled their own coffers with this toxic paper, losing hundreds of billions of dollars. A somewhat breathless March 31Financial Times article proclaimed the closing of the worst month for hedge funds since the collapse of the infamous Long Term Capital Management in 1998. But the average fund tracked by the Chicago-based firm Hedge Fund Research declined by a mere 2.4 percent in March, bringing the cumulative fall for the first quarter of 2008 to 2.7 percent. By contrast, the bank-heavy financial services component of the S&P 500 fell 12.3 percent in the first quarter.

Hedge funds, for the most part, have weathered the storm remarkably well.

Simply put, if underregulation was the problem we would logically see worse performance from hedge funds than investment banks seeing that hedge funds are relatively unregulated financial vehicles.

While I blame the present problem on years of overly exuberant credit expansion by the Fed, I think it is an economic mystery why loose credit disproportionately funded a bubble in the mortgage market versus any other area of the economy (in the same way that it is mysterious why technology was overextended in the late ’90s). Put simply, we do not know why the mortgage markets bore the brunt of the Fed’s policy, but hopefully we can at least be resolved to do two things: a) not let the central banks devalue our money to the extent they have been doing this decade and b) avoid government bail-outs participants in these financial markets, which will create the same incentives to make bad investments that cause the problem in the first place.

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The What’s regulation got to do with the credit problem? by New School Politics, unless otherwise expressly stated, is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 United States License.