The Big Picture on Financial Deregulation

Chapman law prof Timothy Canova has a superb article on the follies of Clinton-era financial deregulation, and their exacerbation under the current administration.

The Clinton administration’s free-market program culminated in two momentous deregulatory acts. Near the end of his eight years in office, Clinton signed into law the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, one of the most far-reaching banking reforms since the Great Depression. It swept aside parts of the Glass-Steagall Act of 1933 that had provided significant regulatory firewalls between commercial banks, insurance companies, securities firms, and investment banks. . . .

Deregulation and lax lending practices were part and parcel of the bubble economy. Clinton often boasted of the rise in homeownership during his presidency, foreshadowing the Bush-Cheney “ownership society.” But for too many, homeownership became something more speculative, a wager that interest rates would not rise in the future, and that if rates did rise, mortgage lenders would allow them to refinance at fixed interest rates based on constantly rising housing prices. . . .

During Clinton years, command-and-control regulation was largely replaced by a risk-based approach that was based on inherently flawed estimates of value and risk. According to risk-based capital requirements, the greater the risk of a loan, the greater amount of capital a bank would be required to raise. But this risk-based approach made little sense when regulators were using inflated market prices to build their defenses. . . .

Free-market fundamentalists will argue that . . . command-and-control regulations would prevent some borrowers from purchasing their first homes, thereby impeding their ability to build up equity capital. This may be, but other incentives could always be offered to help low- and middle-income families save money for future homeownership, such as a tax deduction for rental payments to match the current mortgage interest rate deduction for homeowners. . . .

I would push this analysis further and ask why the “ownership society” has become such a political desideratum in the first place? One key reason is the shredding of the social safety net in so many areas. When deregulated, private insurance markets leave one constantly worrying if the next illness will be covered, it can be quite comforting to think about one’s home equity as a down payment for chemo. As Jacob Hacker has discussed in the Great Risk Shift, social policies that shift the burden of economic volatility from government and business to individuals can only be justified if those individuals think they’ve got some economic reserve capable of cushioning the blow.

In this as in many other areas, debt has been used to hide the real chasms in buying power opened up by growing inequality. Now we’re paying the price for following laissez-faire advice:

Since the early 1980s, the value of home equity loans outstanding has ballooned to more than $1 trillion from $1 billion, and nearly a quarter of Americans with first mortgages have them. That explosive growth has been a boon for banks. Banks’ returns on fixed-rate home equity loans and lines of credit, which are the most popular, are 25 percent to 50 percent higher than returns on consumer loans over all, with much of that premium coming from relatively high fees. However, what has been a highly lucrative business for banks has become a disaster for many borrowers, who are falling behind on their payments at near record levels and could lose their homes.

Anyway, anyone who enjoyed the ‘Glom discussion of Partnoy’s work will find Canova’s Dissent piece interesting.

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