The idea seems straightforward enough:

“The Great Recession has everything to do with deregulation and letting companies do whatever they want in the free market.”

It’s an interesting premise that seems feasible on the surface. Of course the topic has been discussed elsewhere ad nauseum, and from all sorts of perspectives. One would get the impression by a quick Google search that, because literally every article they read assumes, in some form, that deregulation and a “return” to free market principles were the culprit, it simply must be true. As is often the case with popularized explanations of things, upon closer inspection we find the devil’s in the details, and things begin to fall apart.

During my search for the candid reality of things, I found all sorts of confusing articles, arguing all sorts of ridiculousness, such as Allen Greenspan and George Bush being advocates of the free market; and that their actions, which were somehow supporting free market principles, were the actual culprit of the crisis; read here if you want to be confused real good by popular economics sophistry. Indeed, policies supported and advocated by Bush and Greenspan were a part of the problem, but perhaps in a different manner than we’re commonly led to believe.

One article that I stumbled upon that actually does have great explanatory power is in a blog by Arkady K., which I will expound upon a bit. Another great resource for the lay person is a book which I highly recommend by Thomas Woods, called Meltdown. In that book, Woods helps bring a lot of disparate pieces together to clear up the confusion and fill in the gaps, and he does it in a down-to-earth manner — it’s quite refreshing.

After thinking about all these different points of view, I personally think the explanation is fairly straightforward; I’ll deal with it in a condensed form here.

The Gramm-Leach-Bliley Act

This Act is generally cited as the primary culprit (certainly according to Mr. Obama), ushering in deregulation of the subprime mortgage market. One will realize upon closer inspection that, as Arkady points out, the GLB Act “was passed by President Bill Clinton and supported by 155 House Democrats (out of 206) and 38 Democrat Senators (out of 45).” Clinton even said that the Act helped the crisis end as quickly as it did in that it provided a way for the big banks to merge investment and deposit branches into one institution, and at the same time said this deregulation was the cause of the crisis! In fact, many have pointed out that most companies didn’t even end up consolidating, or they had already done things to this effect prior to the legislation and no issues were seen to arise from this.

The clear explanation for these contradictory aspects is that it was certainly NOT deregulation on a large scale and leftists suddenly having a change of heart in running to free market principles. But instead, it was more of the same coming from Washington. Namely, it was yet more regulation to protect and further entrench businesses that sought to monopolize the financial industry through the force of government.

So is there anything to back that suspicion besides reasonable guesses? Ron Paul, the most staunch advocate of the free market in Congress at the time, spoke out in a speech in 1999 strongly against the Gramm-Leach-Bliley Act, some of which I’ve included here:

“The negative aspects of this bill outweigh the benefits. Many have already argued for the need to update our financial laws. I would just add that I agree on the need for reform but oppose this approach. Such a scenario would put added pressure on the financial bubble. The growth in money and credit has outpaced both savings and economic growth… Government policy and the increase in securitization are largely responsible for this bubble. In addition to loose monetary policies by the Federal Reserve, government-sponsored enterprises Fannie Mae and Freddie Mac have contributed to the problem… The better alternative is to repeal privacy busting government regulations. The same approach applies to Glass-Steagall and S. 900. Why not just repeal the offending regulation? In the banking committee, I offered an amendment to do just that. My main reasons for voting against this bill are the expansion of the taxpayer liability and the introduction of even more regulations. The entire multi-hundred page S. 900 that reregulates rather than deregulates the financial sector could be replaced with a simple one-page bill.”

So you have to ask, was this man speaking what he actually believed? Did he know what he was talking about? If you look at the bill and its results, do they line up with what he says? Absolutely they do. The only other remote explanation in my mind is that it was all an elaborate plan to fool people on all sides, and they all worked together to do it. As crazy as that sounds, the idea that it was meant to actually deregulate and move towards a free market seems crazier given the facts.

So, let’s dig in a bit to the actual culprit(s)…

Fanny Mae & Freddie Mac

At the heart of the debacle were two entities, Fanny Mae & Freddie Mac. There are a few things that should be noted about them:

  • Both of them enjoyed special privileges through government. Tax and regulatory breaks that other mortgage guarantors did not enjoy.
  • They had access in various ways to the US Treasury line of credit, as they were quasi-government agencies.
  • Everybody knew that because of their special stance of government favor, they would be bailed out if they failed, thus creating an incentive to deal in risky loans, i.e. a moral hazard.
  • Because of these conditions, these entities were allowed to attract more capital than they otherwise deserved had they actually been subjected to market forces.

The Community Reinvestment Act

Under the guise of anti-discrimination in lending, this was quite unabashedly designed to force companies to give mortgages to people that were not at all capable of fulfilling them. This legislation really took hold and had power during Clinton’s administration, which lines up well with the timeline where the housing bubble was being built, and certainly wasn’t backed down during the Bush administration.

The Federal Reserve

This should be seen as the most important piece to the puzzle. Allen Greenspan, just as he was about to be replaced, led the Federal Reserve to undertake a massive increase in the amount of credit available to the market by creating negative interest rates. This credit channeled in a large way into the mortgage sectors, encouraging credit to be allocated toward a market that wasn’t ready to support that investment, i.e. it encouraged malinvestment, waste. Combine this with mandates from Congress under the guise of Affordable Housing (houses for everyone!) for Fannie and Freddie to reach certain lending quotas, as they had 65% of the market share, they set the lending standards in the industry, and thus the bubble must inevitably form. As it has done time and time again throughout its sorry 100-year existence, the Federal Reserve, in collaboration with Congress, fostered a bubble which was destined to burst.

Summary

There’s a lot of theories that have been thrust into the public’s view that attempt to explain the causes of the so-called “Great Recession”, and they all claim the Gramm-Leach-Bliley Act amounted to deregulation, which then led to the terrible banking practices, predatory lending and the whole works. Nobody can actually support this claim with evidence, only misdirection and confusion. What we can factually observe is the fed’s policies and their effects on the economy as credit is made artificially cheap, and the results of arbitrarily, altruistic, housing quotas mandated by Congress, and the clearly cozy relationship the certain institutions have with government, as they are bailed out, as if that wouldn’t make the situation worse!

It’s interesting to me how you can find a different article geared toward a different audience, with different political beliefs, and the explanation will be the same — too much freedom, deregulation, and unchecked capitalism! Anytime one deals with economic issues, they have to be certain to dig for the facts, because somebody somewhere will want to create a popular belief for the masses to help entrench their destructive, self-serving policies…as always, follow the money!