The Collegian
Friday, March 01, 2024

Wall Street is not the only villain

Richmond College '10

A second attempt at a "bailout" plan finally made its way through Congress last week and was signed into law by President Bush. Its basic premise is the purchase of illiquid assets through an auctioning mechanism. In short, the government will create a temporary demand for assets that is not currently prevalent in the private market alone. Accompanying the bailout plan along its tumultuous journey during the past several weeks have been fervent calls for a crackdown on Wall Street. As the blame game rages out of control, many of the real reasons we find ourselves in this current situation have been obscured.

Wall Street is not innocent. Clearly, there were many practices on Wall Street by investment banks that were less than ideal. The large leveraging and risky loan ventures compounded the crisis in the wake of the housing market bust. One would not be hard-pressed to find examples of corruption on Wall Street as John McCain and Barack Obama in particular have reminded us. In fact, they have both led rallying cries against millionaire executives running multi-billion dollar corporations. But neither candidate has been self-reflective enough to highlight Washington's hand in this debacle. Their cohorts on Capitol Hill have been equally silent as well. To entirely pin our current woes on Wall Street implies that the private sector is the primary villain. This, by necessity, presupposes that the government has been clean of sin and is trying to play the role of the hero.

If we rewind time for a brief instance, there are examples galore of how the government directly contributed to the financial crisis. Indeed, a sound argument could be made that the government deserves as much or more blame than Wall Street. The first stone was cast in 1933 with the passage of the Glass-Steagall Act. This established the FDIC and officially separated the investment bank from the commercial bank. Fast forward up to the more recent past and a trail of loose monetary policy, housing subsidies and easy credit becomes visible. The Fed's adherence to holding interest rates so low for so long started the avalanche. During the early 2000s in particular, low rates led to an increase in the infamous sub-prime lending as well as the housing bubble. Thus, one can see that if the Fed had maintained a more responsible stance towards the interest rate we may have avoided our current troubles.

Next, we turn to Fannie Mae and Freddie Mac. These publicly backed corporations could borrow at reduced rates and fueled the sup-prime hysteria in an effort to provide more low-income housing. The politicians on Capitol Hill were either oblivious to the situation, or (the more likely scenario) were willing to turn the other cheek on Fannie and Freddie's practices because the increases in housing made them look good.

In terms of private corporations, the government depends on independent credit-rating agencies such as S&P, Moody's and Fitch to deem if the assets companies hold are safe or not. The government's hand in this arena was a case of over-regulation in which they only allowed for a small number of these agencies to handle an entire market. The agencies proved to be very poor judges as many of the assets they deemed safe turned out to be extraordinarily risky.

Interestingly, hedge funds and private-equity corporations were the least regulated firms during this time. They also have had the fewest problems during the crisis staying afloat. As the Wall Street Journal editors noted with irony last week: "This reaffirms the historical truth that regulators almost always discover financial excesses only after the fact." Thus a simple, blunt push for more regulation is not likely to solve our financial woes.

So while McCain and Obama scream for more regulation, questions still abound about whether regulation is the only -- or even right -- answer to the problem. Even more disconcerting is the premise that more regulation and government oversight contributed directly to the problem. A two-pronged solution is necessary for preventing a similar crisis in the future. Washington's finest need to be honest with the American people and place blame where blame is due -- on Wall Street and on Capitol Hill.

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