Regulatory Repentance

By April 20, 2010Economy, Regulations

The abstract from a new American Enterprise Institute paper by Charles Calomiris, “The Political Lessons of Depression-Era Banking Reform“:

Ironically, the primary motivations for the main bank regulatory reforms in the 1930s (Regulation Q, the separation of investment banking from commercial banking, and the creation of federal deposit insurance) were to preserve and enhance two of the most disastrous policies that contributed to the severity and depth of the Great Depression-–unit banking and the real bills doctrine. Other regulatory changes, affecting the allocation of power between the Fed and the Treasury, were intended to reduce the independence of the Fed, while giving the opposite impression.

The ill-conceived banking legislation of the 1930s took very little time to pass, but a great deal of time to disappear. The overarching lesson is that the aftermath of crises are moments of high risk in public policy. The Great Depression provoked banking reform legislation that was quick, comprehensive, and unusually responsive to popular opinion. Each of these three aspects increases the risk that regulation will have adverse consequences.

Click here to read the full paper as an Adobe Acrobat PDF.

Calomiris’ colleague at AEI, Peter Wallison, examines more recent history in financial regulation in today’s Wall Street Journal, “Fannie and Freddie Amnesia“:

Now that nearly all the TARP funds used to bail out Wall Street banks have been repaid, the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac stand out as the source of the greatest taxpayer losses.

The Congressional Budget Office has estimated that, in the wake of the housing bubble and the unprecedented deflation in housing values that resulted, the government’s cost to bail out Fannie and Freddie will eventually reach $381 billion. That estimate may be too optimistic.

Indeed, the Treasury removed the $400 billion cap that limited federal investment in the GSEs. So, potentially more to come.

The story is all too familiar. Politicians in positions of authority today had an opportunity to prevent this fiasco but did nothing. Now—in the name of the taxpayers—they want more power, but they have never been called to account for their earlier failings.

As we’ve noted before, Wallison, a former White House and Treasury official, predicted the collapse of Fannie and Freddie years before the actual events. The foresight makes him well worth attending to on other regulatory issues.


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