George Melloan’s column in the Wall Street Journal discusses the new Basel capital standards and correctly observes that 22 years of global banking regulations have not generated good results. This is not because requiring reserves is a bad thing, but rather because such policies do nothing to fix the real problem. In the case of the United States, easy money policy by the Fed and a corrupt system of Fannie Mae/Freddie Mac subsidies caused the housing bubble and resulting financial crisis. Yet these problems have not been addressed, either in the Dodd-Frank bailout bill or the new Basel rules. Indeed, Melloan points out that Fannie and Freddie were exempted from the Dood-Frank legislation.
There’s something to be said for holding banks to higher capital standards, even at the cost of more constrained lending and slower economic growth. But the much-bruited idea that Basel rules will make the world freer of financial crises is highly doubtful, given current political circumstances. The 2008 financial meltdown was not primarily the result of lax regulation but of co-option and abuse of the U.S. financial system by the political class in Washington. The federal government’s “affordable housing” endeavors, beginning in the 1990s, allowed and even forced banks to make highly risky mortgage loans. Those loans were folded into mortgage-backed securities (MBS) sold in vast numbers throughout the world, most promiscuously by two government-sponsored enterprises, Fannie Mae and Freddie Mac. The Federal Reserve contributed a credit bubble that caused house prices to soar, a classic asset inflation. When the bubble began to deflate in 2007, the bad loans in mortgage securities became poisonous. The MBS market seized up, and financial institutions holding them became illiquid and began to crash. The Lehman Brothers collapse was the biggest shock. The only way Basel standards might have helped prevent this would have been if they had been applied to Fannie and Freddie as well as to banks. They weren’t. President Bill Clinton exempted the two giants from Basel capitalization rules because they were the primary instruments of a federal policy aimed at helping more lower-income people become homeowners. This was a laudable goal that ultimately wrecked the housing and banking industries. Washington has learned nothing from this debacle, which is why the next financial crisis is likely to have federal policy origins and may come sooner than we think. Fannie and Freddie—now fully controlled by Uncle Sam and exempt from the Dodd-Frank financial “reform” legislation—are still going strong, guaranteeing and restructuring loans while they continue to rack up huge losses for taxpayers. …The record since the Basel process began 22 years ago doesn’t generate faith in banking regulation either. Basel rules didn’t prevent the collapse of Japanese banking in 1990, they didn’t prevent the 2008 meltdown, and they are not preventing the banking failures that plague the financial system even today.
P.S. The bureaucrats and regulators who put together the Basel capital standards were the ones who decided that mortgage-backed securities were very safe assets and required less capital. That was a common assumption at the time, so the point is not that the Basel folks are particularly incompetent, but rather that regulation is a very poor substitute for market discipline. Letting financial firms go bankrupt instead of bailing them out would be a far better way of encouraging prudence.
[…] Is it helpful for the Basel folks to push for rules increasing systemic risk? […]
[…] Though many banks were steered into also investing in mortgage-backed securities thanks to other misguided government regulations. […]
[…] bottom line is that Fannie and Freddie, at best, undermine prosperity by diverting money from productive […]
[…] Is it helpful for the Basel Group to push for rules increasing system risk? […]
[…] The so-called Basel Rules contribute to the mess in Europe by directing banks to invest in supposedly safe government […]
[…] important to recognize that easy-money policies last decade created too much liquidity and that corrupt subsidies and preferences for Fannie Mae and Freddie Mac steered much of that excess liquidity into the housing sector. These […]
[…] it’s important to avoid unsustainable booms, such as the government-caused housing bubble and easy-money policy from last […]
[…] cap presumably wouldn’t have stopped the Fed’s easy-money policy. Nor would it have prevented Fannie-Mae and Freddie Mac from subsidizing a housing bubble. So we presumably still would have suffered a financial […]
[…] strongest example for my position is what happened with the “Basel” banking rules. International regulators were the ones who pressured financial institutions to invest in both […]
I am really impressed with your writing skills as well as with the layout
on your blog. Is this a paid theme or did you customize it yourself?
Either way keep up the nice quality writing, it is rare
to see a nice blog like this one these days.
[…] be a good idea if everybody agreed to abide the same rules for weighing risks. This resulted in the Basel rules that tilted the playing field in favor of mortgage-backed securities, thus helping to create and pump up the housing bubble. And we know how that turned […]
[…] references to the Basel regulations are particularly noteworthy. These are the rules, cobbled together by regulators from different […]
[…] stunned that he could talk about the housing meltdown and mortgage crisis without mentioning the Federal Reserve, Fannie Mae, or Freddie Mac. Sort of like analyzing World War II and pretending Germany and Japan didn’t […]
[…] I’ve criticized the United Nations for wanting global taxes. I’ve condemned the International Monetary Fund for promoting bigger government. I’ve even excoriated the largely unknown Basel Committee on Banking Supervision for misguided regulations that…. […]
[…] I’ve only once touched on the role of the Basel regulations on capital […]
[…] I’ve criticized the United Nations for wanting global taxes. I’ve condemned the International Monetary Fund for promoting bigger government. I’ve even excoriated the largely unknown Basel Committee on Banking Supervision for misguided regulations that…. […]
[…] I’ve criticized the United Nations for wanting global taxes. I’ve condemned the International Monetary Fund for promoting bigger government. I’ve even excoriated the largely unknown Basel Committee on Banking Supervision for misguided regulations that…. […]
[…] I’ve criticized the United Nations for wanting global taxes. I’ve condemned the International Monetary Fund for promoting bigger government. I’ve even excoriated the largely unknown Basel Committee on Banking Supervision for misguided regulations that…. […]
[…] #split {}#single {}#splitalign {margin-left: auto; margin-right: auto;}#singlealign {margin-left: auto; margin-right: auto;}.linkboxtext {line-height: 1.4em;}.linkboxcontainer {padding: 7px 7px 7px 7px;background-color:#eeeeee;border-color:#000000;border-width:0px; border-style:solid;}.linkboxdisplay {padding: 7px 7px 7px 7px;}.linkboxdisplay td {text-align: center;}.linkboxdisplay a:link {text-decoration: none;}.linkboxdisplay a:hover {text-decoration: underline;} function opensingledropdown() { document.getElementById('singletablelinks').style.display = ''; document.getElementById('singlemouse').style.display = 'none'; } function closesingledropdown() { document.getElementById('singletablelinks').style.display = 'none'; document.getElementById('singlemouse').style.display = ''; } Fannie Mae and Freddie Mac Must Be Shut DownFannie Mae and Freddie Mac Robo signingGuaranteed to Fail: Fannie Mae, Freddie Mac and the Debacle of Mortgage FinanceFannie, Freddie, Basel, and the Fed […]
Fannie-Freddie Bailout: $148B and Counting…
Checked ou your blog and linked back with a trackback I like it so much!…
CNBC’s John Carney (and as far as I can tell nobody else) has touched on the implications of Basel III for GSE Agency Debt. If the $5.6-odd trillion of Fannie’s & Freddie’s legacy book plus additional mortgages they buy to keep the US real estate market moving end up as, say, Tier 2 low-risk assets under Basel III, what amount of this stuff is likely to end up on banks’ balance sheets, and what is that likely to do down the road?
Specifically, is there a chance that when the present Treasury program of unlimited GSE support via buying F&F preferred shares runs out on Dec 31, 2012 that there will be so much agencies exposure in the financial services industry that OMB will have to throw up its hands and affirm that the stuff after all enjoys an explicit guarantee like Rep. Garrett was trying to get Sec. Geithner to admit six months ago?