People who say things like, “I saw this coming as the derivatives market exploded in the mother of all bubbles back in 02-04, I realized how it would end, and sunk all of my money in gold” (what a piss-poor strategy for someone who foretold the future) have already decided that derivative markets are evil and no amount of commenting will show them the light.

I can’t see how one can look at a situation where derivatives, and massive numbers of bets on bets called credit default swaps, exploded from a few trillion to 1.5 quadrillion dollars in less than a decade, and conclude that the resulting crisis was the result of too much regulation. Growth like that is not possible without massive fraud, in my opinion.

Credit default swaps, CDS, were deregulated in a bill passed through Congress with Republican votes in 2000 and signed by Bill Clinton.

And it isn’t something as simple as regulation or deregulation but the issue of discretionary policy. If people think the government is going to bail them out if things get too bad, then people will be less cautious. There are multiple versions of this in economics. In insurance it is called moral hazard. If you insure someone then they might be less careful since the insurance reduces their losses in the bad state/outcome. In discretionary government policy it goes by the name of time/dynamic inconsistency. Typically one finds applications to monetary theory and the potential inflation/unemployment trade-off, but it can work in other areas.

Think of it more of a problem that government will rarely if ever find just the right amount of regulation. Credit Default Swaps can serve a useful function. Futures contracts are a form of derivative and help stabilize certain markets like agricultural markets which without futures contracts can have significant issues with very serious boom and bust cycles given the lag in prices. But if the government is going to start backing in some fashion types of derivatives/CDS and not others then you can some problems. For example, Ginnie Mae, a government agency, will back up the mortgages made under their auspices. Fannie and Freddie backed the paper that they created when generating MBS and could in theory borrow from the U.S. treasury.

Deregulating partially in that environment and toss on the accounting scandal at Fannie and Freddie and the push for “affordable housing” and a desire to keep the good times going and you have a big mess. But, to pretend it is all Bush’s fault is the viewpoint of either and ignoramus or blind partisan fool. I let people pick whatever catagory they think best fits them if they want to insist on this “blame just one guy” veiw point.

For example Bush wanted to increase oversight and regulation of Fannie and Freddie, but was stopped by the Democrats. The Republicans helped repeal Glass-Steagal which was a factor. Bill Clinton signed several of these bills. Then there are the horrible incentives many financial institutions set up that induced employees to focus on the short term. CRA was one of the policy vehicles under which many of these changes were made and that was put in place back in the late 1970′s. Fannie Mae traces its origins to our last huge financial crisis the Great Depression. Mortgage Backed Securities were created by Ginnie Mae in 1970, IIRC. Fannie and Freddie created the bulk of MBS’s.

The idea that one simple little act of deregulation or regulation or re-regulation, whatever you want to call it, would have saved the day is…well stupid.

I don’t know a ton about economics, but my suspicions are that W’s regulatory actions follow the axioms.

Mike Shedlock goes by Mish, saw this coming, and is very much an Austrian economist (i.e. libertarian). You’ll find yourself agreeing with him a lot, once you wrap your head around all of these fake investment vehicles floating around.

http://globaleconomicanalysis.blogspot.com/

Professor Roubini, the so called Dr. Doom, was right about the danger of the derivatives back when that got you laughed at, and though he is a Keynesian economist, and thus pro-intervention in the markets, he has a good comprehensive understanding of the subject.

http://www.rgemonitor.com/blog/roubini

And if Dr. Doom is too optimistic for you, you could read The Automatic Earth; though Stoneleigh and Ilargi tend to write a -perhaps- too bearish editorial each day, they have a great talent for selecting the most important financial stories of the day, and presenting them in a concise format. Great for speed readers.

http://theautomaticearth.blogspot.com/

Read a few dozen books, attend a few lectures, and read those blogs for a few years and perhaps you will also understand why we are well and truly f^(%ed.

But, you know, just because ‘I’ve got mine’ doesn’t mean I’m going to lie down and let a bunch of bankstas enslave mankind for generations to come under crushing debt. Perhaps that empathy disqualifies me from your capitalist club, but I guess my soul is too precious a thing for me to issue securities on, even if they would get a AAA rating.

How is it that people who knew nothing about financial markets, or economics in general, a month ago have already pinpointed the exact cause of the current financial mess? While the so-called experts have only begun to sift through the seemingly infinite data, genuises like Li figured out that the real cause is “massive numbers of bets on bets called credit default swaps.” Of course it’s a just a coincidence that the answer is a three-letter acronym (anything more complicated would require human level thought) and fits perfectly with his worldview (capitalism is teh ghey).

“In God We Trust” on our money cracks me up. What you better trust is if you don’t pay the tax/extortion, however high our rulers decide it should be, the Kings men will take your home and e-credits and throw you in the debtors prison. When they finally centralize all commerce into one government corporation I hope there’s a giant bronze statue of Bush in front of every government store. (Kind of like the Stalin one)

If you have kids, steer them towards government jobs. The Kings men will always be fed.

George Will should stick to baseball, ’cause he doesn’t know squat about the current financial mess.

You do realize the amount of spending on regulatory agencies is completely different from actual regulating? The Bush EPA, for instance, seems to have a bunch of “regulators” who spend their time working with companies to find ways to evade regulations and using their regulatory power to preempt the State of California (among others) when it tries to enforce minimum standards.

This may technically qualify as “regulating” because it involves a regulatory agency doing something, but it is certainly not what people mean when they refer to regulating and someone being a “regulator.”

After all, the subprime loans could be payed off with a ‘mere’ 200 billion, which is far less than the 3 trillion that the world has spent to put more water in behind a huge leaking dam of derivatives. And when that dam breaks we will all be saddled with a debt greater than all of the worlds GDP several times over. I can’t remotely predict what might happen as a result of that, because that has no precedent. The banks continue to sit on these huge mounds of casino toilet paper, rather than come to grips with the fact that it has no intrinsic worth. That’s why they are hoarding cash; they are hoping to be able to cancel out the huge piles of anti-cash in their vaults.

One last point. A large price tag does not buy either results or competence; that is surely one of the great lessons of the Bush administration. Don’t be blinded by ideology, Radley; I’m no fan of regulation, but allowing fraud on this colossal scale is not deregulation, it is turning a blind eye to the robbing of all the world, and your children, and their children, and their children.

The GSE’s might have been a screw up, but if they were the sole cause the whole problem would have gone away with their nationalization.

The larger problem that caused the housing bubble, the credit crisis, and the stock market crash is a private sector issue.

George Will:

It is hard to state the truth with more elegant imprecision. In fact, much of the crisis we are in today is because the government set out to fiddle the market. We had regulation in effect with legislation that would criminalize, as racism and discrimination, if you didn’t lend to non-productive borrowers. We had Fannie Mae and Freddie Mac existed to rig the housing market. Because the market would not have put people in homes that they could not have afforded.