Securitization and Uncle Sam: Crisis Causes are Still Worth Considering

When Congress returns from recess there are going to be a lot of fights. Health care is the one dominating the public square right now, but the regulation overhaul of Wall Street will have just as much impact, if not more, on the lives of Americans. It might be harder to see on a day-to-day basis how the technical side of financial services regulation impacts our daily lives than the delivery of health services, but with our dynamic economy, so goes New York and Chicago… so goes the nation. We saw this first hand when the Wall Street crisis began hitting home with small businesses, individuals, and potential home-buyers left out in the cold for a few months as credit seized up.

So in this break period for Congress, there is a bit of breathing room to look back and try to get a grasp on what the crisis causes were in order to really understand how we should move forward. I wrote a commentary last month about the history of deregulation that is helpful for this exercise. But a good place to start is this paper by economist Arnold Kling from his Congressional testimony about eight months ago. It is a little old, but it is a good narrative of the crisis from a 2008 perspective.

Kling writes in his executive summary:

Reinvestment Act for what happened is wrong. To blame financial deregulation for what happened is wrong. The narrative I present following this executive summary describes a combination of government failure and market failure.

I blame excessive securitization, induced by regulatory anomalies, particularly with regard to capital requirements. These anomalies were responsible for the unwarranted expansion of Fannie Mae and Freddie Mac as well as for bank participation in the phenomenon of private securitization of subprime mortgages.

I don’t agree with everything he says, pretty much everyone disagrees with the narratives of others on some points. But core argument of this paper is solid.