As I've
explained before (see "Economic Foolishness" link below), regulatory
errors are not benign - in cases like the 2008 financial crisis, they are
catastrophic. Have you ever wondered how peculiar it is that so many bankers
made the same mistakes in the build up to the crash? Dozens of bankers making
dozens of different mistakes wouldn't have brought about the grave dangers
associated with what happened - it was the imprudent regulations that
facilitated the crash by generating self-similarities in mistake-patterns .
Here are a couple of examples unearthed this week by investigators Jeffrey
Friedman and Wladimir Kraus.
Regulations
like the Basel accords
and the US’s
recourse rule directed banks to rationalise their preferences from mortgage
debt to business debt. Other regulations directed banks to rationalise their preferences
towards targeted agencies, which led to the retardation of competitive forces.
Have a look at City A.M’s report
and see how closely it resembles what I was saying about the cause of the
crisis in this Blog post Economic
Foolishness: The Truth About Bankers' Bonuses & Government Subsidies about
a year ago - most notably:
1) "The recourse rule – pushed through by the Fed and other
regulators – was deliberately designed to steer banks’ funds into CDOs – and it
worked a treat. The banks gorged on them. No fewer than 93 per cent of their
holdings of mortgage-backed securities were either AAA-rated or were issued by
Fannie or Freddie, as stipulated by the regulations; as far as the banks were
concerned, they were merely following the new best practice. "
2) Because they owned so many CDOs,
retail banks suffered more than any other investors – except investment banks,
which packaged mortgages into CDOs and were caught out with stocks of both when
the music stopped. The recourse rule only covered commercial banks; hedge
funds, insurers and others were not cajoled into buying CDOs. It is clear that
the US authorities were therefore not only complicit but also directly
responsible for the destruction of the US banking system. Their rule also
helped inflate the demand for CDOs, securitisation and even sub-prime
mortgages, especially when Wall Street had run out of mainstream mortgages to
bundle up.
3) The authors remind us that the
crisis was not directly caused by mortgage defaults – rather, it was triggered
by a collapse in the market price of CDOs caused by fears about the effect of
declining house prices. It was this which decimated balance sheets – not
mortgage defaults per se. Had the regulatory system not encouraged retail banks
to hold securitised bundles of hard-to-value, opaque CDOs, and instead treated
other assets more fairly, the crisis might have been avoided.
4) The 1988 Basel I accords favoured
the use of off-balance sheet vehicles such as structured investment vehicles
(SIVs), which became huge in the UK and Europe and had a similar effect on the
demand for CDOs. By 2006, Basel II began to be implemented outside America; it
contained similar incentives to those contained in the recourse rule. The
regulatory induced pro-CDO madness had gone global. Needless to say, nobody
responsible for these pernicious regulations has been sacked. Bureaucrats, it
seems, always get off scot-free.
* Picture courtesy of
themoderstevoice.com
