Meltdown: It's Not Just a Matter of Greed

Various people explain the current financial crisis as a result of “greed.” There is, however, no indication of a change in the degree or extent of greed on Wall Street (or anywhere else) in the last several years. Greed is a constant. If greed were the cause of the financial crisis, we would be in financial crisis pretty much all the time.

But the financial markets have not been in perpetual crisis. Nothing close to the current crisis has taken place since 1929. Yes, there was 1987 and the savings-and-loan debacle of that era. The current crisis is already more dramatic—and threatens to get a good deal worse. This crisis emerged over the last decade and appeared full-blown only at the beginning of 2008 (though, if you were looking, it was moving up on the horizon a year or two earlier). The current mess, therefore, is a change, a departure from the normal course of financial markets. So something has to have changed to have brought it about. The constant of greed cannot be the explanation.

So what changed? The answer is relatively simple: the extent of regulation changed.

As a formal matter, the change in regulation is most clearly marked by the Gramm-Leach-Bliley Act of 1999, passed by the Republican-dominated Congress and signed into law by Bill Clinton. This 1999 act in large part repealed the Glass-Steagall Act of 1933, which had imposed various regulations on the financial industry after the debacle of 1929. Among other things, Glass-Steagall prohibited a firm from being engaged in different sorts of financial services. One firm could not be both an investment bank (organizing the funding of firms’ investment activities) and a commercial bank (handling the checking and savings accounts of individuals and firms and making loans); nor could it be one of these types of banks and an insurance firm.

However, the replacement of Glass-Steagall by Gramm-Leach-Bliley was only the formal part of the change that took place in recent decades. Informally, the relation between the government and the financial sector has increasingly become one of reduced regulation. In particular, as the financial sector evolved new forms of operation—hedge funds and private equity funds, for example—there was no attempt on the part of Washington to develop regulations for these activities. Also, even where regulations existed, the regulators became increasing lax in enforcement.

The movement away from regulation might be seen as a consequence of “free market” ideology, the belief as propounded by its advocates that government should leave the private sector alone. But to see the problem simply as ideology run amok is to ignore the question of where the ideology comes from. Put simply, the ideology is generated by firms themselves because they want to be as free as possible to pursue profit-making activity. So they push the idea of the “free market” and deregulation any way they can. But let me leave aside for now the ways in which ideas come to dominate Washington and the society in general; enough to recognize that deregulation became increasingly the dominant idea from the early 1980s onward. (But, given the current presidential campaign, one cannot refrain from noting that one way the firms get their ideas to dominate is through the money they lavish on candidates.)

When financial firms are not regulated, they tend to take on more and more risky activities. When markets are rising, risk does not seem to be very much of a problem; all—or virtually all—investments seem to be making money. So why not take some chances? Furthermore, if one firm doesn’t take a particular risk—put money into a chancy operation—then one of its competitors will. So competition pushes them into more and more risky operations.