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Despite Media 'Mythmaking,' Capitalism Didn't Fail


Free-market economists blame government actions taken during Carter, Clinton for financial crisis. 
October 2, 2008
By Julia A. Seymour
Business & Media Institute

Speaker of the House Nancy Pelosi blasted free market capitalism (and the GOP) in front of the entire nation on Sept. 29 as the debate raged over a potential $700 billion bailout.

     "They claim to be free market advocates when it's really an anything goes mentality. No regulation, no supervision, no discipline," Pelosi said, according to CBS "Evening News" that night.

     But did deregulation and "unfettered capitalism" really lead to the financial crisis gripping Wall Street? The answer is yes, according to politicians on both sides of the aisle and the news media. They're wrong, according to many economists including George Mason University economist Dr. Don Boudreaux who called it "utter mythmaking."

     The networks have also attacked free markets and blamed a lack of regulation for the current Wall Street problems - but haven't explored regulations that actually created them.

     Former and current anchors and reporters including Sam Donaldson, Chris Cuomo, Carl Quintanilla and others bashed the free market and deregulation in September. In contrast, the three broadcast networks didn't talk about the Community Reinvestment Act of 1977 during the month, even though economists argue that CRA generated many of today's financial problems.

     CNBC's Jim Cramer admitted his predisposition toward regulation on ABC's "Nightline" Sept. 17.

     "I wanted a more proactive government, one that's less ideological, so to speak. One that is more regulatory. These guys were not inclined to do that. They actually - and I still hear them do it. They believe in the market," Cramer said.

     The host of "Mad Money" has been all over the mainstream media lately. He's been interviewed by ABC, NBC and CNBC about the financial situation. Cramer was even on Martha Stewart's show to repair chairs on Oct. 1.

     Both senators vying for the presidency have blamed deregulation and Wall Street "greed" for the monetary mess. According to Sen. Barack Obama, D-Ill., under the Bush administration, "we've had policies that have shredded consumer protections that have loosened oversight and regulation."

     Sen. John McCain's, R-Ariz., rhetoric wasn't much different. McCain denounced "mismanagement and greed [that] became the operating standards while regulators were asleep at the switch" and lashed out at Securities and Exchange Commission chairman Christopher Cox on Sept. 18.

     The New York Times reported that Cox, a regulator, was arguing for more regulation, according to a Sept. 27 Times article titled "S.E.C. Concedes Oversight Flaws Fueled Collapse." An MSNBC subhead summarized the argument: "Crisis sparks anger over executive salaries, lax regulation."

     Despite the anti-free market tone of many network stories about the financial crisis there are still many defenders of capitalism. Economists and other experts argued on Bloomberg.com, Forbes.com and in the editorial pages of The Wall Street Journal and Investor's Business Daily (IBD) that the economic turmoil facing the U.S. was actually caused by government regulation.

     Economist and Business & Media Institute advisor Dr. Walter E. Williams explained in a Sept. 17 column that the "credit crunch and foreclosure problems are failures of government policy."

     What "foolhardy government policy" was Williams referring to? The CRA, which "intimidated lenders" into offering credit to more people and specifically "discourages them from restricting their credit services to low-risk markets, a practice sometimes called redlining."

     Thomas J. DiLorenzo of the Von Mises Institute called CRA "extortion" on banks in an April 30 article. That story explained that CRA was created during the Carter administration and in order to comply with the regulation mortgage securitization "exploded during the 1990s as a result of government regulation." Securitization bundling was an attempt to diversify risks from loans made to high-risk borrowers.

     CRA regulation was also strengthened under President Bill Clinton in the 1990s, according to Terry Jones of IBD. His article called the subprime mortgage crisis "inevitable" after Clinton's changes.

     Other regulations including Sarbanes-Oxley, which enforced mark-to-market accounting (fair value accounting) by imposing criminal penalties, also had a hand in this subprime crisis. Mainstream media have all but ignored the government's role in creating the problem in favor of repeating campaign rhetoric. Network reporters didn't mention Sarbanes-Oxley in September at all - although a couple interviewees made the connection and suggested "throwing out Sarbanes-Oxley."

More Regulation, the only Media Option

     The same news media hawking the up-to-$700 billion bailout plan that was voted down on Sept. 29 have lambasted free markets and "deregulation" - just like politicians and left-wing bloggers.

     "Good Morning America's" Chris Cuomo claimed Sept. 22 that "one thing your money is supposed to buy in the bailout is more regulation." There was no question whether more regulation might be the wrong answer to the crisis.

     ABC's "World News with Charles Gibson" found an economist to promote more regulation on Sept. 16. David Wright's story included Tom Gallagher, a political economist with Wall Street research firm ISI Group, who said "Everybody's for tighter regulation here." Although Gallagher cautioned that regulation could make it harder for some people to get credit.

     CNN's Lisa Sylvester mentioned CRA on Sept. 29 "Lou Dobbs Tonight." But she mischaracterized as "deregulation" the 1990s changes that actually strengthened CRA rules.

     The constant assault on deregulation meant there simply was only one position to take - in favor of "re-regulation." "Everyone is now for re-regulation," Sam Donaldson said on ABC's "This Week" Sept. 21. Donaldson claimed that Reagan's deregulation had to be "cleaned" up and implied that deregulation from 1999 and 2000 caused today's debacle.

     "We deregulated beginning '99 and 2000, the banking industry, Phil Gramm and others, I think that Obama ad is correct. He was one of the prime movers. Now we're gonna have to clean that up at great expense," Donaldson said.

     CBS "Face the Nation" host Bob Schieffer even let Rep. Barney Frank, D-Mass., go unchallenged on Sept. 21.

      Frank complained about the "irresponsible decisions" of the private sector and inadequate regulation. Frank chairs the Congressional committee responsible for oversight of Fannie Mae and Freddie Mac - the two government-sponsored enterprises that were recently taken over by the U.S. government because of bad mortgage debt.

     Frank, who was involved romantically with a Fannie Mae executive for 10 years while serving on the committee, defended Fannie and Freddie against accusations of mismanagement and worked to block efforts by the Bush administration to increase regulations of the organizations.

     According to IBD, CRA turned banks into "pliable, easy targets" of groups like liberal advocacy group ACORN (Association of Community Organizations for Reform Now) and "no bank CEO wanted to be mau-maued as an enemy of the poor."

     In the 1990s, Clinton "broadened the CRA in ways Congress never intended," according to IBD Sept. 24. Clinton's Housing and Urban Development secretary, Andrew Cuomo (Chris Cuomo's brother) made changes that let Fannie Mae and Freddie Mac into subprime markets "in a big way."

     "That's how it began. Later, in the Clinton, era, Fannie Mae and Freddie Mac got involved - buying up bad loans from banks, and securitizing  them for sale on world markets. The seeds of the subprime meltdown were planted," IBD said. All on Frank's watch.

Government Intervention - the Heart of the Crisis

     As the crisis in the financial sector took hold, the networks were quick to ask what or whom was to blame. The answer was predictable: "greed," free markets and President Bush's deregulatory policies.

     Brian Williams wondered "how we got here" on Sept. 15 "Nightly News." The answer came from CNBC's Carl Quintanilla: "Some call it payback for years of risky lending practices and weak regulation."

     ABC's Chris Cuomo let borrowers off the hook, but accused the government of fiddling while Rome burned on Sept. 22 "Good Morning America" segment about the possible Wall Street bailout. Cuomo criticized Wall Street bankers and scorned "government watchdogs, including the Federal Reserve and Congress looking on."

     Asking how we got here was an essential question, but the networks only seemed to be looking for one type of answer. Instead of talking to a free market economist for another perspective, Cuomo included liberal Economic Policy Institute economist Clyde Prestowitz, who told viewers, "You had totally unsupervised markets that married with new instruments that no one understood."

     IBD, Walter E. Williams, the Foundation for Economic Education and other economists have each said that the markets were regulated (even over-regulated) not "unsupervised," as Prestowitz claimed.

     As for the complicated financial instruments - that's exactly where Fannie Mae and Freddie Mac made their government-sponsored living. BMI advisor and Hillsdale College economist Professor Gary Wolfram said Fannie and Freddie were at the heart of this mess.

     According to Wolfram, market economies are "fundamentally sound." When there are "gyrations" you should look for the government cause for the problem. In this case, Wolfram explained, "Government started out doing this by creating Fannie Mae and Freddie Mac in the first place. They became government sponsored enterprises and what happened is they went out and set up this secondary mortgage market."

     Combined with a below inflation Federal funds interest rate, the government encouraged "excess borrowing" and "malinvestment," Wolfram said.

Cancerous Regulation

     Another regulatory tumor that led to Wall Street's troubles was Sarbanes-Oxley, t government regulation enacted in 2002 as a reaction to the Enron, WorldCom and other accounting scandals.

     According to a Forbes.com commentary from former Speaker of the House Newt Gingrich, Sarbanes-Oxley carried criminal liabilities that "have driven accountants to stricter and stricter accounting evaluations."

     Brian Wesbury, chief economist of First Trust Advisors, told Dave Ramsey on Fox Business that the "overreach" of Sarbanes-Oxley mandated mark to market accounting - which he said made sense for liquid assets like stocks, but not for illiquid assets like bundles mortgage securities.

     "I believe mark to market accounting has created about 65-70 percent of the mess that we are in today. So it is really a reaction to Enron, an overreaction to Enron that is helping create problems today," Wesbury said.

     Mark to market accounting requires that assets be marked for sale at whatever price the market will bear - even if you have no intention of selling those assets.

     Wesbury explained it in a Sept. 22 "Monday Morning Outlook:"

Imagine if you had a $200,000 mortgage on a $300,000 house that you planned on living in for 20 years. But a neighbor, because of very special circumstances had to sell his house for $150,000. Then, imagine if your banker said you had to mark to this "new market" and give the bank $80,000 in cash immediately (so that you would have 20% down), or lose your home. Would this reflect reality? Not at all. Would this create chaos? Absolutely.

     According to Wesbury, Wolfram and one Wall Street Journal op-ed, this is exactly what has been happening all over Wall Street.

     The fire sale prices of mortgage securities has caused markdown after markdown and unless the accounting rule is suspended "the cancer will keep spreading," according to the William M. Isaac's Journal op-ed. Isaac was chairman of the Federal Deposit Insurance Corp. from 1981-1985.

     "If we do not halt the insanity of forcing financial firms to mark assets to a nonexistent market rather than their realistic economic value, the cancer will keep spreading and will plunge the world into very difficult economic times for years to come," Isaac said.

     Recognizing the problem with mark to market accounting, the SEC decided on Sept. 30 to "ease" mark-to-market rules, according to the Phoenix Business Journal.

     Yet, politicians and the networks alike are calling for another regulatory response. The trouble with that is - as Hoover Institute senior fellow Richard Epstein put it, "Bad regulation metastasizes."

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