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Since the beginning of the turmoil in the financial markets that is now commonly referred to as the “financial crisis,” many voices have asserted that this is a “crisis of capitalism.” These are not merely the voices of socialist groups, who could be expected to see this event as a vindication of their views;1 government officials also joined the chorus, as did many commentators on financial matters. As Samuel Brittan observed early in the mortgage meltdown that ultimately became the financial crisis, “Any failures on the financial side are sure to bring the opponents of capitalism out of their burrows. Pundits who until recently conceded that ‘capitalism is the only game in town’ are now rejoicing at what they hope is the longed-for death agony of the system.” Billionaire investor George Soros, who had been arguing at least since 1997 that the capitalist system was “coming apart at the seams,” finally found vindication, telling a group in New York in February 2009, according to a Bloomberg News summary, that “the current economic upheaval has its roots in the financial deregulation of the 1980s and signals the end of a free market model that has since dominated capitalist countries.” In 2009, the debate over the responsibility of capitalism for the current crisis rose to such significance that the Financial Times ran a gloomy series on the future of capitalism.
An examination of these contributions shows that, with the exception of the socialist view, the critics are not actually recommending the abandonment of a market system but only the imposition of stronger forms of government control over markets through greater regulation and supervision. Much of the rhetoric about crises or failures of capitalism either posits a straw man–an unfettered laissez-faire capitalism that does not exist in the United States, or for that matter anywhere else–or suggests that excessive deregulation has allowed banks to take excessive risks. It has certainly not been the policy of the U.S. government to allow financial markets to “regulate themselves,” as some have claimed, although safety and soundness regulation–the supervision of the financial health of institutions–has been limited at the federal level to banks and to two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. Such regulation is logical because commercial banks are backed by the government through deposit insurance, a lender of last resort facility offered by the Federal Reserve, and a Federal Reserve payment system to which only banks have access. The GSEs, although not explicitly backed by the government, were seen in the markets as performing a government mission and, hence, as being government backed. Once any kind of financial institution is seen as being backed by the government, market discipline is severely impaired, and–to protect itself against losses–the government must impose some kind of safety and soundness regime.
Other major participants in financial markets–securities firms and insurance companies–are not backed by the government and are thus subject to a far less intrusive regulatory regime than banks are, but they nevertheless function within a complex web of regulation on business conduct and consumer protection. The condition of the banking industry today, far from offering evidence that regulation has been lacking, is actually a demonstration of the failure of regulation and its inability to prevent risk taking. Because this is not the first time that regulation has failed to prevent a major banking crisis, it makes more sense to question whether intrusive and extensive financial regulation and supervision is a sensible policy rather than to propose its extension to other areas of the financial sector.
What most critics of the current system do not seem to recognize is that the regulation of banks has been very stringent, particularly in the United States. As I will show, the commercial banks that have gotten themselves into trouble did so despite strong regulation. This is an uncomfortable fact–maybe what some would call an “inconvenient truth”–for those in the Obama administration and elsewhere who are advocating not only more regulation but also extending it to the rest of the financial system.
Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at AEI.
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