Arnold Kling  

Financial Crisis Inquiry Commission

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Does anyone care about the report of the Financial Crisis Inquiry Commission? Keith Hennessey, Bill Thomas, and Douglas Holtz-Eakin write,


Brookings Institution economists Martin Baily and Douglas Elliott describe the three common narratives about the financial crisis. The first argues that the primary cause was government intervention in the housing market. This intervention, principally through Fannie Mae and Freddie Mac, inflated a housing bubble that triggered the crisis. This is the view expressed by one of our co-commissioners [Peter Wallison] in a separate dissent.

The second narrative blames Wall Street and its influence in Washington. According to this narrative, greedy bankers knowingly manipulated the financial system and politicians in Washington to take advantage of homeowners and mortgage investors alike, intentionally jeopardizing the financial system while enjoying huge personal gains. That's the view of the six majority commissioners.

We subscribe to a third narrative--a messier story that emphasizes both global economic forces and failures in U.S. policy and supervision.

Read the whole thing. Although their analysis is more nuanced than that of the commissioners they criticize, in the WSJ op-ed they fail to discuss the role of bank capital requirements and regulatory capital arbitrage in creating an unstable financial system. In their more extended dissent they talk about capital regulation.

Regulatory capital standards, both domestically and internationally, gave preferential treatment to highly rated debt, further empowering the rating agencies and increasing the desirability of mortgage-backed structured products.

A big point that they make is that many simplistic explanations of the crisis do not explain its international dimensions. As the above paragraph indicates, bank capital regulations can account for the international aspects.

I still recommend Not What They Had in Mind and What Caused the Financial Crisis?


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COMMENTS (4 to date)
Amaturus writes:

The Basel I and II were heavily influenced by the economic thinking from German and Switzerland, both economies where housing prices are very stable. While it makes sense to have a 50% capital requirement for mortgage loans in Germany, that in no way made sense in Spain. Now look what happened to the Spanish banks. They had nowhere near enough capital to deal with the shock of their housing bubble bursting and now the government is partially nationalizing the financial system. That's good for exactly no one. Sometimes international cooperation is good, but we need to acknowledge that economies are different enough to warrant different requirements, which means a centralized one-size-fits-all response---like the Basel accords---is nonsensical.

Lord writes:

Wall Street is very international. It seems you would both want to explain it internationally, not just where it boomed, but where it didn't. Texas comes to mind where regulation worked quite differently.

Heather writes:

The criticism of the regulatory system reminds me of the development of the Greek financial crisis which reached its peak after the EU officials didn't reveal the information they had about the irresponsible government spending. I think the international organizations need to establish a much better system of financial regulation.

Tom Grey writes:

further empowering the rating agencies

The big open secret is that too much MBS junk was wrongly rated AAA by the regulation empowered top three agencies. Where are the lists of what financial products they rated AAA, and what happened over time to those ratings?

Allowing AAA debt to be used, like money, as Tier 1 capital, is what caused the bubble.

Proposed solution: There should be restrictions on total quantity of AAA debt -- and once that total is reached, only new debt that displaces old debt should get listed.

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