THE BUMBLING COLOSSUS By Henry F. Field

The Regulatory State vs. the Citizen; How Good Intentions Fail and the Example of Health Care;
A New Progressive's Guide
(available at amazon.com)

Bank Crisis Causes and why there is a Slow Recovery

What caused the crash? And how do we fix what went wrong? Those are two crucial questions which need solid answers for our future financial security, as a nation and as individuals.

On page 11-12 of The Bumbling Colossus, and later at 187-188, the author states:

"The Dodd-Frank Act of 2010 did nothing about the real causes of the financial crisis -- the government-spurred push on banks and GSEs (Fannie, Freddie, Ginnie, FHA, VHA, etc) to make mortgages to non-creditworthy homebuyers through 'affordable housing mandates' -- and instead counterproductively heaped additional regulatory burdens on banks and deprived them of needed sources of revenue." (The errors of Dodd-Frank are further elaborated at pp 201-08.)

So what did cause the crash? And what should we fix to lower the chances of a repeat?

No more credible analysis can be found than that of Wake Forest Business Professor John A. Allison. A life-long student of economics and philosophy, he also happens to have spent the last 45 years immersed in the banking and finance world, the last 20 or so as CEO of BB&T, one of this country's largest bank holding companies. As such he experienced, worked on as an insider, and observed the successive waves of excess and regulation through the Paul Volker monetary tightening of 1980-82, the S & L crisis of the late 1980's, the real estate crash of 1992, the internet bubble of 1997-2000, the internet crash of 2002, and the mortgage/housing boom of 2002-2007 and subsequent housing and finance crash of 2008-2010. Plus of course the slow drip torture of the 1-2% "recovery" since.

His book is John A. Allison, "The Financial Crisis and the Free Market Cure" (McGraw-Hill 2013). The bulk of the book is on the causes of the problems, their origins and effects, and towards the end he offers his solutions based upon analysis of the causes. His credibility comes because, although many people went through those same events, few were at the helm over the whole period as he was, and fewer still have the background and knowledge in economics and finance which grounds his work in reality.

You will learn the role of the Federal Reserve's monetary policy in smoothing out the business cycle during the period 2000-2007, actions which while benefiting some, ended up obscuring the signals which would have informed the market that the housing binge was unsustainable and therefore made things worse. You will learn the role of the SEC in destabilizing bank balance sheets by enforcing "fair value" mark to market accounting where conditions were inappropriate. Also the SEC's enthronement of an oligopoly of credit ratings agencies and harmful bank balance rules. Also the role of federal deposit insurance promoting risky "free lunch" behavior. You will learn concretely and from perhaps our most informed source the role of banks in the economy and how they operate by leveraging deposits.

Here's some extracts:

On the role of the Media: "The financial crisis is the most important economic event in 80 years. It will have a significant impact on the quality of your life and that of your children. The vast majority of the explanations for the crisis and the ensuing recession presented in the popular press are not true. Destructive policy decisions are being made based on this misidentification of the causes of our financial problems. If you misidentify the causes, you will, of necessity, propose the wrong cures. The Great Recession and the failed recovery (this is the slowest recovery in American history) are best explained by understanding the impact of all types of incentives on the behavior of business leaders, who are the ultimate job creators."

"Unfortunately, both the popular press and many academics have provided arguments that lack basic understanding, ranging from the simplistic greed on Wall Street argument to the idea that complex derivative instruments such as CDOs, SIVs, and CDSs (the 'shadow banking system') caused the crisis. Much of the information has been presented in 'sound bites' by commentators, who do not understand economics, or academic articles by professors, who have never been in business and do not understand how government policy incentives human behavior. The effect has been to create misunderstanding and confusion."

On the role of Greed: "In the end, the laws of human nature drive all economic activity. This book is about the impact of government incentives on the decisions of 'real-world' decision makers, that is, human action. .... The idea that there was a sudden burst of greed on Wall Street is childish. Yes, there are always individuals and firms on Wall Street that have a desire for the unearned. ...There has always been greed on Wall Street. However, we did not have a sudden burst of greed that caused the financial crisis. The causes are far deeper, longer-term in nature, and far more destructive. Our educational system, especially our 'elite' universities, played a far more significant role in the destruction of wealth than greed on Wall Street did. The ideas that those elite universities are currently teaching our future leaders pose a fundamental threat to our long-term prosperity."

On our supposed "Free Market" economy: "We do not live in a free-market economy in the United States; we live in a mixed economy. The mixture varies significantly by industry."

"Technology is one of the least regulated industries in the U.S. It should be noted that technology continued to perform well in the difficult economic environment. Financial services is a very highly regulated industry, probably the most regulated industry in the world. It is not surprising that a highly regulated industry is the source of many of our economic problems. By the way, if you do not believe that financial services is highly regulated, obtain a copy of the state banking, Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), Federal Reserve, Securities and Exchange Commission (SEC), or other agency regulations document that affects the industry. The claim that the financial industry was deregulated is a myth...."

How Regulation often cuts against Human Nature and Progress: "Humans have a fundamental nature as thinking beings who must make independent judgments that are based on the facts and that use their ability to reason."

"In reality, government regulations prevent businesspeople from being innovative and from thinking creatively. In my career, I have seen a number of significant opportunities to add products and services that would unquestionably benefit our clients, and yet some law made this impossible. All human progress is, by definition, based on creativity, because anything that is better is different. Creativity is possible only for an independent thinker. Someone who is not creative, who cannot innovate, cannot contribute to human progress. Government policies often provide incentives for destructive activities and prevent productive innovations."

"These regulatory policies are typically based on a fundamental misunderstanding of human nature, the means of human survival, and the nature of the production process. Ideas have consequences. We need to ensure that our future leaders are taught ideas consistent with the laws of nature and human nature, which are the foundation for a successful society and individual happiness."

On the role of Good Intentions: "Intentions that are called 'good' often do not produce favorable outcomes. This is particularly true when these good intentions are based on false premises and a lack of understanding of what motivates human actions. Sometimes, unfortunately, the so-called good intentions actually reflect a lust for power , the desire to control others, and the belief that you are smarter than the people you are going to 'save'.

On "too big to fail" and Crony Capitalism: "Individual financial institutions (Wall Street participants) made very serious mistakes that contributed to the crisis. These institutions should have been allowed to fail. However, any errors by these institutions, individually and collectively, are far less important than government policy mistakes, and almost all the errors were the direct result of government policy incentives. [Many had a history as crony capitalists], that is, these companies did not advocate limited government but instead sought special favors for themselves. Goldman Sachs, Citigroup, and Countrywide are examples of crony capitalists. Crony socialist is probably a better name for these individuals and firms. If the U.S. had separation of 'business and state' as it does separation of 'church and state', crony capitalism (or crony socialism) could not exist."

On Housing as the Root Cause of the Crash: "The primary cause of the Great Recession was a massive misinvestment in residential real estate. We built too many houses, too large houses, and houses in the wrong places."

"Underlying this massive misallocation of capital to residential real estate was a belief that home prices appreciate forever and that housing is a great investment. This false belief was based on a long-term trend of home appreciation that was driven by a long history of government policies supporting investment in the housing market.

The Harm in Lost Jobs: "In economic terms, spending on housing is consumption, not investment. We live in a house, and therefore we consume the house. Houses are not used to produce other goods. ... You can spend your money only once. If you spend it on houses, you cannot spend it on manufacturing plants. While houses create jobs while they are being built, once they are built, they do not create jobs going forward. A manufacturing plant creates jobs when it is being built, but, more important, it continues to create jobs as long as it operates. In fact, it is jobs that create houses, not houses that create jobs.

"When you shift capital (money) from production to consumption, you reduce your future standard of living. ... This is analogous to having partied for years in the Caribbean and now finding that we have a really bad 'hangover' and a giant credit card bill."

"We cannot afford to build the manufacturing plants now because we wasted our capital building houses that we did not need. In addition, the government is taking the capital that we do have and spending it on pork barrel projects or projects that are not economically justified (clean energy), so these good jobs may never be created."

For anyone seeking to be informed on our banking system and how regulations have incentivized private bank behavior to great harm, this book is the bible.

John A. Allison, "The Financial Crisis and the Free Market Cure" (McGraw-Hill 2013).

"The Bumbling Colossus" is available at amazon.com