On Monday Tim Geithner was sworn in as Treasury secretary, thereby
becoming the official face of the Obama administration's economic team,
which includes Geithner's mentor and former boss Larry Summers. And
while Geithner and Summers grapple with the crisis, the media is
grousing over what role their old boss, President Clinton, had in
setting the stage for it.
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The latest critic of the former president is London daily The Guardian, which has assembled an intriguing list
of the "Twenty-five people at the heart of the meltdown." There are
some curious names, including President Clinton, but the list also
includes the usual suspects, including George W. Bush and Alan Greenspan
who are inarguably linked to the calamity -- not to mention some
questionable absences (former SEC chiefs, who were tasked to oversee
investment banks, come to mind) that could make for a separate post.
As for Clinton's role, The Guardian writes:
Clinton shares at least some of the blame for the
current financial chaos. He beefed up the 1977 Community Reinvestment
Act to force mortgage lenders to relax their rules to allow more
socially disadvantaged borrowers to qualify for home loans.
In 1999 Clinton repealed the Glass-Steagall Act, which
ensured a complete separation between commercial banks, which accept
deposits, and investment banks, which invest and take risks. The move
prompted the era of the superbank and primed the sub-prime pump. The
year before the repeal sub-prime loans were just 5% of all mortgage
lending. By the time the credit crunch blew up it was approaching 30%.
These assertions cropped up during the recent presidential
campaign, prompting some economists (and Clinton himself) to question
the validity of them, which are specious at best. There is no
challenging the fact that Clinton did beef up CRA, and formally repeal
Glass-Steagall. What is questionable is the role these changes had in
setting the stage for the crisis.
Independent economists and the Federal Reserve's own staff
have debunked CRA's role in the subprime meltdown. First a little
history. CRA was established to prevent commercial banks and other
retail depository institutions from discriminating against entire
neighborhoods, a practice called "redlining." The law has nothing
directly to do with the growth in subprime borrowing, which was
promoted by finance companies not covered by the law. Additionally,
most CRA loans are rated as prime.
It is harder to quantify the impact Glass-Steagall's repeal had on
the crisis. All the repeal did was formally allow for the removal of
the wall between commercial banking and investment banking, which had
already eroded, mostly through regulatory changes earlier in the
decade. The repeal of Glass-Steagall allowed for the creation of
universal banks, exemplified by the creation of Citigroup Inc. But did
the creation of universal banks cause the problem?
The answer is no. At its core, Glass-Steagall was intended to protect
depositors from losing their savings by preventing commercial banks
from behaving like investment banks. Amid the current crisis, no U.S.
depositor has faced that issue.
Instead, The Guardian could have made a better case for Clinton's
role in the crisis if it focussed on the cause of the crisis, the abuse
of leverage, which began growing under his tutelage. - Matthew Wurtzel
Comments
The crisis was caused by a number of factors, but the enormous leverage built by the investment banks was the underlying reality without which the avalanche could not have happened.
There Mr Clinton helped. The repeal of Glass Steagall did not adverely affect the clearing banks, but it did ignore the reality that the investment banks had become the repositories of the savings of the nation. It then followed that the fatal leverage of the investment banks destroyed the savings of many. These were not deposits in the classic sense, but they should have been so regarded.
Others contributed mightily, but Mr. Clinton is certainly not without responsibility.
For verification of the thesis, look at the Canadian system, where the major investment banks, owned by the clearing banks, could not and did not contaminate their balance sheets.
The mistake, therefore, was that in abolishing the distinction between clearing banks and investment banks, the system did not impose requirements for prudential risk management upon the latter.
So repeal of Glass Steagall assisted the disaster by doing only half the job.