Having addressed the initial cause of the current financial crisis – irresponsible monetary policy by the Fed – and before moving on to the culpability of government sponsored (that is, “run”) entities, let’s take a moment to examine the sheer mendacity of the New York Times editorial board who, a bit less than two weeks ago opined, “Don’t Blame the New Deal”.

The editorial, published September 27 begins with the assertion that “[t]his year’s serial bailouts are proof of a colossal regulatory failure … [as] antiregulation disciples of the Reagan Revolution have eliminated vital laws, blocked the enactment of much-needed new regulations, or simply refused to exercise their legal authority “  There’s only one problem with that position: it is absurd on its face.  There is, in fact, not a single example of deregulatory action that can be demonstrated to have contributed to the current crisis in any way.  That does not, however, dissuade the Times from making a valiant, if misguided, attempt to show otherwise.

The first club out of the Times’ bag is “predatory lending”, a staple of liberal demagoguery and economic illiteracy.  The editorial complains that Greenspan, and subsequently Bernanke – who, as already examined, have more than sufficient responsibility for current conditions – failed to heed a congressional mandate to curb this practice.  There’s only one problem: it doesn’t exist.  It cannot possibly exist.

The concept of predatory lending is based on the premise that unscrupulous lenders will trick unwary borrowers into taking loans that they cannot possibly afford in order to rake in big bucks at borrower expense.  The problem, of course, is that defaulted loans are vastly more expensive than any revenue stream than could possibly be earned before failure occurs.  In order for the “predatory lending” scenario to be possible, an entire industry must be staffed with people who knowingly and willfully chose to act against their own interests.  Utter nonsense.  While some unscrupulous mortgage generation shops may have been willing to say anything to get people in the door, such actions cannot convince ultimate lenders to underwrite the risks.  That requires a market distortion of gargantuan proportions … and in that regard, the Fed was happy to oblige.

The next canard out of the bag was the suggestion that limits on shareholder lawsuits passed in 1995 in some way opened the floodgates to misstatement of financial condition.  Nothing could be further from the truth.  The Private Securities Litigation Reform Act of 1995 required nothing more than that the plaintiff in such a suit demonstrate that he suffered economic harm due to a deliberate “material misrepresentation or ommission”.  That protects no one from the kind of activity the Times alleges took place under a “sense of immunity”.  Moreover, the editorial absurdly blames the Enron fiasco on this change even though the company’s actions were unequivocally fraudulent – thus, obviously not impacted by the law change – and began before the legislation was passed (shadow companies were set up beginning in the early 1990s).

The Times, however, wasn’t finished.  It had to hold forth on the greatest indignity of them all – the dismantling of something created under the sainted Roosevelt Administration (which created Fannie Mae in the first place, but that’s a topic for another day).  In 1999, Congress dismantled much of what remained of the Glass-Steagall Act, described by the Times as “a pillar of the New Deal, which separated commercial and investment banking”.  Conspicuously ommitted from the Times’ analysis is the fact that the US is the only country in the world to make such distinctions – and financial institutions in those countries have not suffered ill effect as a result.  It was, in reality, the artificial distinctions under Glass-Steagall that placed the Savings & Loan industry in jeopardy in the 1970s; specifically, as interest rates spiralled out of control – also the result of irresponsible govermental actions – savings and loans faced a rapid outflow of low interest deposits into higher paying securities while their assets were tied up in long-range mortgage securities.  Under Glass-Steagall, S&Ls were unable to diversify as wihdrawals rapidly drove them toward bankruptcy.  By the time Congress acted to fix this problem, which could only have resulted in the collapse of the industry even in the absence of deregulation, the cure was frequently too late and, in cases, S&Ls were in the position of needing to offer products with which they had no experience and little understanding.  The rest is history.

If anything, both the S&L crisis and the current financial meltdown can be blamed in large part, not on the repeal of Glass-Steagall, but on the artificial distinctions that were created under Glass-Steagall in the first place.

Finally, the editorial takes two more completely baseless swipes at the deregulatory (or lack of regulatory) activity over the last eight years, first bemoaning the exclusion of derivatives from the Commodity Exchange Act of 1936 and then blaming the current administration for failing to reform Fannie Mae and Freddie Mac in 2005 because “President Bush wanted to fully privatize them and feared that if they were adequately reformed, privatization would lose steam”.  The first of these assertions I’ll come back to; the second is flatly absurd.  Absent from the selective memory of the writers is the fact that the president doesn’t get to sign legislation until it passes both houses of Congress and the measure was killed in the Senate Committee on Banking, Housing, and Urban Affairs under the Chairmanship of none other than Christopher Dodd (D-CT), who, by some strange coincidence, has received more political contributions from Fannie Mae than any other human being.

As a side note, the obtuseness of the Times editorial board is particularly evident in its clear disdain for the notion that Fannie Mae and Freddie Mac might be privatized even though that would likely have prevented these entities from making the problem worse as the private sector would not have permitted the continued accumulation of unwarranted risk and would almost certainly have detected the chicanery of Franklin Raines much sooner.

That leaves the claim that it was the proliferation of derivatives outside of commodity exchange oversight that caused the problem.  Here, again, the disease is ignored in favor of a symptom.  The unregulated free market is perfectly capable of correctly pricing the risks of essentially any financial instrument.  It is only when pricing signals are radically distorted either by rampant manipulation of the liquidity markets by government in the guise of the Fed or the explicit socialization of losses for certain investment vehicles by the government in the guise of government sponsored entities or both as happened in this particular case that the market cannot perform this function properly and chaos ensues.