President Obama gave a rousing speech today on the proposed financial reforms.
We know that financial regulations can bring far greater stability to the economy. Even Milton Friedman and Anna Jacobson were forced to acknowledge that the FDIC “succeeded in achieving what had been a major objective of banking reform for at least a century, namely, the prevention of banking panics.”
My concerns focus on what was not addressed by the president by seems every bit as important as regulatory reform. The asset bubble that burst in 2007/08 was itself a product of public policy decisions. To be more specific:
- Ongoing regulatory pressure for relaxed underwriting standards as a means of promoting social goals (e.g., higher levels of home ownership, and under Bush, the “ownership society”)
- The Federal Housing Enterprises Financial Safety and Soundness Act of 1992, which mandated that HUD set quantitative targets for GSE purchases of mortgages serving a low and moderate-income clientele (the target would ultimately reach 55 percent).
- The Taxpayer Relief Act of 1997 that exempted the first $500,000 in gains from any home sale (for couples, $250,000 for single filers)
- Persistent trade deficits that provided funds for reinvestment in mortgage-backed securities combined with Greenspan’s pursuit of historically low interest rates
Voters who can use homes they can’t afford as ATMs to purchase goods they could not otherwise justify may be quite content, even if the policies that make this all possible simultaneously create the preconditions for an asset bubble.
The president, in focusing exclusively on regulatory reform, seems content with changes that will reduce the extent to which, when the next bubble bursts, the collateral damage will not be as great. It feels like mandating that all cars have better airbags before liquoring up a teenage boy and handing him the car keys. Without the liquor, the need for better airbags might not be as great.
What would be necessary to assure that future elected officials won’t pursue social policy goals (e.g., creating an “ownership society”) that have the unintended consequences witnessed in the past few years?