Repealing Glass-Steagall did not create the banking monster

Property rights violations are the Frankenstein, not deregulation.

TAMPA, August 22, 2012 – As we approach the Republican and Democratic National Conventions with two major party candidates that don’t substantively disagree on anything, debate about the causes of the housing bubble and what should be done about it will inevitably recur.

Both candidates advocate massive government intervention. They just disagree about the details.

Neil Barofsky weighs in with the generally accepted argument that the repeal of Glass-Steagall was the creator of what he calls “the monster,” highly leveraged investment banks taking extraordinary risks that led to the 2008 financial meltdown.

Barofsky is right about Wall Street being a monster, but the repeal of Glass Steagall wasn’t its Frankenstein. As Tom Woods explains in his bestseller, Rollback,

“But did the repeal of two provisions of Glass-Steagall allowing affiliation of commercial banks with securities firms through their control by the same holding company contribute to the losses and risk that permeated the system? Certainly not. For one thing, commercial banks bought mortgage-backed securities for their AAA rating, their attractive return, and the minimal capital requirements associated with holding them; they did not acquire these assets because they were connected to investment banks that were trying to unload them.

Moreover, severe regulatory firewalls essentially prevent this kind of affiliation from contributing to losses or increased risk on the part of the commercial bank involved. The reverse problem, that affiliation with a commercial bank might bring down and investment bank, is exceedingly unlikely, given the relative magnitudes of assets held by each institution. The commercial banks’ assets were only a tiny fraction of those held by the investment banks they were affiliated with. These banks were in no position to cause the investment banks any serious problem, much less their complete downfall.”

If that’s true, then why was that “sucker going down,” as President Bush so eloquently put it?

Like all economic distortions, the root cause was a fundamental violation of property rights. For the past century, American society has been built upon a foundation where property rights are routinely violated and then regulations are put in place to try to control the inevitable distortions that result. It’s like piling up sandbags to try to stop a tsunami.

There are several property right violations that cooked up this disaster.

The first is inflation by the Federal Reserve System. This is the granddaddy of all the rest because without it, the available funds to make those risky investments wouldn’t have existed. Inflation by the central bank violates property rights by making purchasing power available to Person A by diminishing the purchasing power of money held by everyone else. Simply put, it’s stealing.

The root of this problem is fractional reserve banking itself. The central bank exists to prevent the inevitable consequences of fractional reserve banking – bank runs.

Throughout most of history, fractional reserve banking was recognized for what it is, a fraud. When a depositor places $100.00 in his account, it is a fraud for the banker to loan out $90.00 of that $100.00 and still guarantee $100.00 to the depositor.

It’s not like depositors are innocent victims, either. Almost everyone knows that the bank is loaning out most of that $100.00, even if it is all withdrawn by the depositor the very next day. Fractional reserve banking is a form of mass insanity, where depositors and bankers both know that the deposits aren’t in the bank but both pretend that they are anyway.

So, a financial system built upon fraud is the first problem.

A second basic property rights violation is the existence of the GSEs, Fannie Mae and Freddie Mac. One of the pillars of the anti-free market argument is that all of the irresponsible loans were the result of people acting voluntarily. Lenders looked the other way while borrowers who couldn’t afford homes borrowed money to buy them.

This assumes that there were only two parties to each of these transactions, but that’s not true. There were three.

In addition to the lender and the borrower, there was a third party participating in the transaction, the taxpayer. The taxpayer, through the GSEs, was providing the collateral for the “liars loans,” removing all of the risk for the lenders in making them.

As always, the taxpayer was not acting voluntarily. Thus, the aberration was not the result of a free market. It was the result of the government intervening to violate the very property rights that it supposedly exists to protect.

This same dynamic is about to play itself out in the student loan market, where identical forces have been at work. All of the familiar symptoms are there: prices enormously inflated due to the artificial demand created by tax subsidization, a large misallocation of labor to a market that cannot support it naturally, too many schools built relative to the number of people who can truly afford to attend.

The meltdown has already started as student loan defaults have exploded. When this bubble bursts, there will be the same consequences in this sector as in housing. All of the misallocated labor will be unemployed, massive losses will occur and schools will stand empty, just as houses do now.

Pundits will point to some inconsequential regulation that was repealed or never passed, as if it would have prevented the inevitable disaster that accompanies violating the law of nature.

The philosopher John Locke, who inspired the American founding fathers, once said, “The great and chief end, therefore, of men’s uniting into commonwealths, and putting themselves under government, is the preservation of their property.”

Instead of preserving it, modern American society is based upon government looting it in a thousand different ways. Until that changes, expect economic monsters to keep roaming the land.

Tom Mullen is the author of A Return to Common Sense: Reawakening Liberty in the Inhabitants of America.


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Thomas Mullen

Tom Mullen is the author of A Return to Common Sense: Reawakening Liberty in the Inhabitants of America. He writes weekly columns on his blog and has been featured on The Daily Caller, The Huffington Post, Daily Paul, LewRockwell.com, 321 Gold! and Peter Schiff’s EuroPac.net. Tom has been a guest on Fox’s Freedom Watch with Judge Andrew Napolitano, Adam Vs. the Man, Free Talk Live, and numerous other programs.

Tom is originally a native of Buffalo, NY and graduate of Canisius College. He earned a Master’s Degree in English from State University of New York College at Buffalo. He now resides with his family in Tampa, FL.

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