Deregulation Acquitted Again

Katherine Mangu-Ward takes on the meme that banking deregulation caused the meltdown in Reason magazine:

The Glass-Steagall Act of 1933 prohibited investment banks from acting as commercial banks, and vice versa. Signed by Bill Clinton (who continues to defend the legislation), the Gramm-Leach-Bliley Act of 1999 repealed those aspects of the law. Many on the left blame at least part of our current woes on that move. With the repeal, Barack Obama said in a March economic address, "we have deregulated the financial services sector, and we face another crisis."

In fact, multiple exemptions to Glass-Steagall had been granted for years before Gramm-Leach-Bliley was signed into law. Most European financial markets, not normally known as more "deregulated" than the U.S., never separated commercial and investment banks in the first place. And there is no correspondence between institutions that benefited from the repeal and those that recently collapsed. Institutions that didn’t take advantage of the Glass-Steagall repeal, such as Lehman Brothers and Bear Stearns, were the ones that failed most spectacularly, in part because they lacked the stability provided by commercial banking deposits.

If anything, Gramm-Leach-Bliley may have softened the blow. The George Mason economist Tyler Cowen argues that Gramm-Leach-Bliley made way for more diversity in the financial sector, and “so far in the crisis times the diversification has done considerably more good than harm.” Under the Glass-Steagall rules, Bank of America and J.P. Morgan Chase would not have been able to acquire Merrill Lynch and Bear Stearns. Nor would Goldman Sachs and Citibank have their current unified form, which may have helped them survive.

There is a significant body of academic work supporting this idea. The Rutgers economist Eugene Nelson White, for example, has found that national banks with security affiliates—the sort of institutions Glass-Steagall was designed to prevent—were much less likely to fail than banks without affiliates.

Agreed. See also Steve Chapman in Reason Online:

If there is anything we have learned from the crisis in the financial sector, it's the urgent need for more regulation. Had federal regulators been more vigilant or wielded greater powers, all this suffering and heartache might have been averted. That's the story we've been told, and it must bring a rare smile to the face of Bernard Madoff. . .

So if regulators had been paying attention, they would have detected what was going on, right? . . . In fact, as The Wall Street Journal reported the other day, the Securities and Exchange Commission had been suspicious of his methods for a long time. It had even heard in 2005 from a competing investment executive who drafted a 21-page report arguing that Madoff was running a Ponzi scheme.

The government had actually investigated him—not once or twice, but "at least eight times in 16 years," according to the Journal. Yet it "never came close to uncovering" the operation, which may have begun as early as the 1970s.

So what makes anyone think that future bureaucrats, no matter how vast their authority, will be able to do better? Advocates of stricter regulation often talk as though the choice for protecting investors is between imperfect market mechanisms and foolproof government regulations. In fact, governments, like every other institution, are staffed by fallible individuals who can be fooled as easily as anyone else.

(via Instapundit)