Five Years Later, Banks Still Mis-Regulated by John Allison

On the fifth anniversary of the Lehman Brothers collapse, it is appropriate to reflect on the lessons learned from the recent financial crisis. This is especially relevant given that we are experiencing the slowest recovery in U.S. history and have more than five million fewer full-time jobs than in 2007.

Advocates of big government have created the myth that the financial crisis was caused by banking deregulation and Wall Street greed.  However, three massive new regulations were passed under George Bush: the Privacy Act, Sarbanes-Oxley, and the Patriot Act. The banking industry was not deregulated, it was misregulated. And while there has always been plenty of greed on Wall Street, there is no evidence of more greed than usual preceding the financial crisis.

The financial crisis was primarily caused by government policy. We live in a mixed economy in the United States — not in a purely free market. The mixture varies by industry. Technology is largely deregulated and has continued to prosper, and financial services is the most regulated industry in the world. It is not surprising that the most regulated industry—banking– is the one with the biggest problems.

The primary culprits were errors made by the Federal Reserve and government housing policy, especially Freddie Mac and Fannie Mae–the giant government-sponsored enterprises that would not have existed in a free market.

In the early 2000s, the U.S. faced a minor correction. Federal Reserve Chairman Alan Greenspan was nearing retirement and being the “maestro” did not want to leave on a bad note.  He caused the Fed to create negative real interest rates, enabling people to borrow at less than the inflation rate. This provided a tremendous incentive for people to leverage, especially in the housing market where home prices were rising rapidly.

A major reason home prices rose so rapidly was the impact Freddie Mac and Fannie Mae had on the affordable housing market (i.e., subprime). In 1999, President Bill Clinton began enforcing a decree that Freddie and Fannie must have at least half their loan portfolio in affordable (subprime) home loans. Since the legitimate subprime market was not that big, as Freddie and Fannie tried to reach this goal, they radically drove down lending standards for home loans and inflated a bubble in housing prices.

The failure of Lehman Brothers became a symbol of the ripple effect of subprime home lending. The irony is that while a significant economic correction was necessary to undue the tremendous mis-investment in the housing market, the panic which is symbolized by the Lehman failure was unnecessary.

I went through the financial corrections of the early 1980s and 1990s with BB&T Bank and there was never a panic. The 1980’s correction was deeper in many ways, but the recovery significantly faster.

The arbitrary nature of regulatory decisions created an unnecessary panic. The regulators saved Bear Stearns but let Lehman fail. They saved Citigroup, but let Wachovia fail. They unjustifiably paid the uninsured depositors at Washington Mutual and thereby stole from the bond holders. Rule of law was thrown out the window, which created the panic. All of which happened under George Bush.

Sadly, we have not had a meaningful recovery because of the destructive monetary, fiscal, and regulatory policies of the Obama administration. The attack on business and the wealthy is good politics, but terrible economic policy.

If you want to learn the inside story on this disaster and the proper solutions, read my book The Financial Crisis and The Free Market Cure.