One for Two

We can do the innuendo
We can dance and sing
When it's said and done we haven't told you a thing
--Don Henley

Former President Bill Clinton was recently interviewed about the banking crisis. One question asked whether he regretted signing the 1999 bill that repealed the Glass-Steagall Act. Also known as the Banking Act of 1933, Glass-Steagall essentially raised walls between units of diversified financial services companies to inhibit capital flows between units. The act was designed to curtail 'excessive speculation' thought to occur when capital between operating divisions was permitted to flow freely (such as between commerical banking units and brokerage units). Interestingly enough, G-S also ushered in the Federal Deposit Insurance Corporation (FDIC).

Given the high level of speculative leverage at the center of today's credit crush, finger pointers are increasingly blaming the 1999 G-S repeal.

Mr Clinton defended his decision, arguing that the repeal has led to more market stability, not less. And he's right. Less regulation, not more, promotes market stability. His example of Bank of America (BAC) being able to gobble up Merrill Lynch (MER), something that couldn't easily be done under G-S, was a good one. He rightly notes that this relieved some pent up market pressure.

In his response to a subsequent question, however, Mr Clinton lost the points he had earned above, and perhaps then some. He was asked whether government should be involved when financial-services firms fail. He replied, well, let's just quote him:

"I think in this case, the [government] had no choice. And I think the longer you wait, ironically, the more you have to do and the more money you have to spend. So, in a funny way, the people who are most against market intervention wind up having to preside over the biggest market intervention that costs the most money because we all know that markets without disclosure, without capital requirements, without market requirements tend to unsustainable extremes."

Of course, we should expect such a reponse because his administration presided over numerous government orchestrated bailouts including the Mexican peso crisis, the Asian contagion, and the Long Term Capital Management debacle.

His reasoning is backwards. It is intervention that builds distortion in the system. These distortions raise free market forces that 'push back' against interventionist measures. The greater the intervention, the more the distortion, and ultimately the larger the cumulative market forces that will be unleashed to move the system towards a more natural state of equilibrium.

Intervention does not lower corrective costs, it raises them. If unshackled, market forces efficiently move systems towards equilibrium. It's been so long since we've actually had anything resembling a free market, I suppose some confusion can be expected since observational or experiential learning has largely been out of the question.

While Mr Clinton may be no more culpable than any other sitting president since the early 1900s, his administration's interventions have surely added to, not subtracted from, the cumulative problems we face today.

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