Jay Reding.com

Could The Financial Meltdown Have Been Avoided?

Megan McArdle has an excellent piece on how the current financial crisis developed, going beyond the spin to get to the real issues that precipitated yesterday’s sell-off. The sort of regulation that would have prevented the subprime meltdown—regulating Fannie Mae and Freddie Mac like private companies—were never seriously considered. Both Fannie Mae and Freddie Mac were allowed to grow into politically powerful quasi-governmental institutions free of the rules that should have prevented their collapse. Democrats who want to blame Republicans have no real argument—neither do Republicans who want to pin this all on Democrats. This was a bipartisan failure through and through.

Neither McCain nor Obama have given any real policy positions on this issue. That’s not surprising, as there aren’t any. Short of building a time machine, the only real solution is to let the market adjust. In a free market there has to be a penalty for failure of some kind. There’s no such thing as a riskless economy, only the mitigation of risk.

The calls for a “9/11 Commission” and more regulation from McCain are nearly as misplaced as Obama’s calls for higher taxes and more regulation. The solution to this mess will not come from the same governmental over-breadth that precipitated it. The market has already given the ultimate corporate punishment to firms like Lehman Brothers—the financial death penalty. Passing more regulations did not stop the subprime crisis. Passing more regulations will not prevent the next one. The only way to prevent these sort of things from happening is to ensure that the markets are transparent, assets are not being hidden off-book, and that bad decisions are punished as they were here. Government can and should play a role in all that, but as Ms. McArdle astutely points out, most of the suggested solutions are politically, economically, or socially untenable. We could mandate 20% down payments on home sales—that would prevent another crash like this one. It would also hurt millions of poor people. We could increase capital reserve requirements, but Spain already does that and they have a home market as unstable as ours.

There aren’t any easy solutions, but politicians will try and give us easy solutions that will end up causing the next crisis when they run headlong into the wall of reality. The saying goes that doing the same thing over and over again and expecting different results is the definition of insanity. It might as well be the definition of politics as well.

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