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The Culprit Is All Of Us By Ss Powell Barrons

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Clarity on Recovery from Present Economic Crisis

Clarity on Recovery from Present Economic Crisis

Published in: Economy & Finance, Business

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  • 1. Monday, February 9, 2009 EDITORIAL COMMENTARY The Culprit Is All of Us By SCOTT S. POWELL The government's meddling got us into this mess. CONTRARY TO A VIEW POPULARIZED DURING THE 2008 presidential election season, the current economic crisis was not the result of deregulation. The Bush administration made many mistakes, but deregulation was not one of them. Not only was there no major deregulation passed during the past eight years, but the Bush administration and a Republican Congress approved the most sweeping financial-market regulation in decades. The bipartisan Sarbanes-Oxley Act was enacted in 2002 to prevent corporate fraud and restore investor confidence after the collapse of Enron and WorldCom. It failed to prevent the accounting fraud and influence-peddling scandals at Fannie Mae and Freddie Mac. And even after those scandals were widely understood, regulators sent Fannie and Freddie back into the market to continue buying subprime loans, lending and borrowing with implied taxpayer backing. Across the government, the Bush administration supported new regulations that added almost 1,000 pages a year to the Federal Register, nearly a record. If this is insufficient regulation, it's hard to imagine a scope that would be effective. We are in this mess largely because critical thought and moral judgment have been subordinated to the politicization of our economy, resulting in regulatory gaps and excessive controls of the wrong kind. Government regulations should be limited to those that increase and protect transparency and competition, protect public and private property, promote individual responsibility and enforce equal opportunity under the law. Even if the right laws and regulations could be found, they would prove insufficient to protect freedom and prosperity.
  • 2. The Foundation of Economics In his farewell address, George Washington said that religion and morality are essential to sustain democracy in America. He might well have added that virtue is just as indispensable to its economy. When the captains of banking and finance and their congressional overseers fail in moral judgment, the results are disastrous for everyone. As we are now witnessing in the real-estate, stock- and bond- market dislocations, once trust is lost, markets freeze and long-standing relationships break down, resulting in illiquidity, irrational pricing and severe losses. Today's problems have their roots in programs and financial instruments that shifted the locus of moral responsibility away from private individuals and institutions to wider circles that were understood to end with a government guarantee. Heads of the top banks and financial institutions could approve substandard home-mortgage underwriting -- prone to increased default -- because those loans could be securitized by Wall Street and sold off to investors or to government-sponsored enterprises (GSEs), with no likely recourse to the financial institution of origin. Our present crisis began in the 1970s, during the Carter administration, with passage of the Community Reinvestment Act to stem bank redlining and liberalize lending in order to extend home ownership in lower-income communities. Then in the 1990s, the Department of Housing and Urban Development took a fateful step by getting the GSEs to accept subprime mortgages. With Fannie and Freddie easing credit requirements on loans they would purchase from lenders, banks could greatly increase lending to borrowers unqualified for conventional loans. In the name of extending affordable housing, this broadened the acceptability of risky loans throughout the financial system. No Surprise The risk lurking in the GSE portfolios was acknowledged in the Bush administration's first fiscal-year budget, released in April 2001. It stated that Fannie and Freddie were quot;a potential problemquot; because quot;financial trouble of a large GSE could cause strong repercussions in the financial markets, affecting federally insured entities and economic activity.quot; Fed Chairman Alan Greenspan issued repeated warnings that the GSEs quot;placed the total financial system of the future at substantial risk.quot; Such warnings went unheeded even after accounting scandals rocked Fannie and Freddie. The collapse and government seizure of Fannie and Freddie in September 2008 ended the experiment in partial socialization of the U.S. housing sector. Before we try complete concentration of federal financial power, we should understand that power and political corruption abrogated moral judgment on every level. The poor and middle class were encouraged to live beyond their means and buy houses they couldn't afford; speculators were lured into excessive risk-taking; banks were rewarded for lowering their loan standards; and Wall Street found new windfall profits from securitizing and reselling bad loans in bulk. With the support of regulators, credit-rating agencies provided cover for the whole charade.
  • 3. Spreading Failure There is plenty of blame to go around on both sides of the political aisle. But the lesson should be clear that socializing failed businesses -- whether in housing, health care or in Detroit -- is not a long- term solution. Expanding government's intrusion into the private sector doesn't come without great risk. The renewing and self-correcting nature of the private sector is largely lost in the public sector, where accountability is impaired by obfuscation of responsibility, and where special interests benefit even when the public good is ill-served. George Washington also warned against excessive partisanship, which distracts public councils and enfeebles public administration. Rather than blaming the party in power or the party formerly in power, the nation should stop living in denial of the mistakes of both parties. Spreading failure across the entire economy risks turning a recession into a depression. Regulatory reform now must foster responsible behavior and financial accountability. Far better for our citizenry and businesses to have a strength and resourcefulness that comes from creativity, honesty and self- reliance than to have a growing dependence on a profligate government. SCOTT S. POWELL is a senior VP at ELP Capital, which manages a commercial real-estate debt-based hedge fund; a visiting fellow at the Hoover Institution; and a Commerce Bridge board member. Editorial Page Editor THOMAS G. DONLAN receives e-mail at tg.donlan@barrons.com. URL for this article: http://online.barrons.com/article/SB123396551669058895.html Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.