Risk manages the market on its own

Richard McCord, Henderson

Friday, Nov. 25, 2011 | 2 a.m.

Mark Twain said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Liberals know for sure that deregulation, and particularly the 1999 reform (not “repeal”) of the Glass-Steagall Act, was a prime cause of the 2008 financial crisis. But Glass-Steagall didn’t prevent the 1980s Latin American debt crisis (where U.S. banks made risky loans to shaky governments) or the 1989-91 savings and loan crisis (where S&Ls made risky loans to shaky real estate deals). The 2008 financial crisis would have occurred even with an unreformed Glass-Steagall still the law of the land.

Glass-Steagall separated commercial banks from investment banks. Its reform allowed them to coexist under a single holding company, though they still must keep their activities and their balance sheets separate. The activities permitted before reform are the same today. Commercial banks still cannot invest in stocks. Glass-Steagall never prohibited them from making risky mortgages to shaky homebuyers and selling them to investment banks. It was enacted partly to prevent another stock market-related crash, which federal banking regulations do today.

Preventing another 2008-style crisis requires disconnecting Congress from the mortgage market: privatize Fannie Mae and Freddie Mac and reform the Community Reinvestment Act. Put risk back in the private sector, where it belongs. Risk is very effective at curbing the appetites of reckless lenders and irresponsible borrowers. Reinstating Glass-Steagall would increase the likelihood of another crisis by creating a sense of security that just ain’t so.