As we prepare for this autumn’s election, the results are in on America’s 30-year experiment with radical economic deregulation. Income inequality has risen to levels not seen since the 1920s and the collapse of the unregulated portion of the mortgage and secondary markets threatens the health of the overall economy.
These two economic failures will be major issues in the forthcoming presidential election, and, importantly, there is an emerging Democratic consensus standing in sharp contrast to the laisser faire Republican approach.
There are two central elements of this consensus. Democrats believe that government’s role as regulator is essential in maintaining confidence in the integrity and fairness of markets, and we believe that economic growth alone is not enough to reverse unacceptable levels of income inequality. In the wake of the subprime mortgage crisis, credit markets round the world contracted sharply in response to concerns among market participants about the value of exotic and opaque securities being offered in largely unregulated secondary markets. This staggering implosion and its damaging and widespread reverberations make it clear that a mature capitalist economy is as likely to suffer from too little regulation as from too much.
With respect to income inequality, since the end of the last recession – a period of steady economic growth – average earnings for the vast majority of workers have fallen in real terms. During this period, after-tax incomes of the top 1 per cent nearly doubled.
Whether because of globalisation, technology or other factors, it is clear that market forces have produced too much inequality and government has not adequately used its capacity to mitigate the impact of these forces.
Conservatives have long argued that government efforts to address these issues would damage the economy. They are, of course, the same people who predicted that there would be an economic disaster after Bill Clinton and the Democratic Congress raised marginal tax rates in 1993, and who opposed other tax increases on upper-income people. Economic growth in the ensuing years was among the strongest in the postwar era. It is now clear that growth in the private sector is consistent with a far greater variation in many aspects of public policy – including taxation and regulation – than conservatives claim. In fact, appropriate intervention with respect to prudential market regulation is necessary to promote growth, and its absence – as we have learned – can retard it.
As recently as a year ago, one often heard the argument that US financial activity would migrate offshore unless we moved to further deregulate markets. There is little evidence to support this claim. In fact, it is now clear that what has been migrating to the rest of the world are the problems associated with securities based on bad loans – often originated by unregulated institutions in the US. Banks in the UK and Germany were forced to close, either as a result of holding large portfolios of these securities or because they could not roll over debt backed by them.
Widespread securitisation, and use of the “originate to distribute” model, has turned out to be far less than the unmitigated boon it had once appeared.
The market did its job with great efficiency in exploiting the benefits of securitisation but government failed to make good on its responsibilities. The failure of regulation to keep pace with innovation left us with no replacement for the discipline provided by the lender-borrower relationship that securitisation dissolves. Increasing and largely unregulated leverage multiplies the corrosive effect of this change.
In response to the current crisis, it appears that the regulatory tide may, at long last, be turning.
In 1994 a Democratic Congress – the last before the Republican takeover marked the arrival of the deregulators – passed the homeowners equity protection act, giving the Federal Reserve the power to regulate all home mortgage loans. The avatar of deregulation, Alan Greenspan, then Fed chairman, flatly refused to use any of that authority.
In contrast, today’s Fed will soon issue rules using that authority. That represents a significant repudiation of the previous view. While the proposals made by the Democratic presidential candidates differ in detail, they are to a substantial extent consistent with the argument I have made here. Their Republican counterparts continue to advocate the hands-off approach pursued by the Bush administration. As a result, we are likely to have a healthy debate about the role of government in supporting a robust capitalist economy in the 21st century. It is important to note that this debate is not about policy details but represents fundamentally different views about the nature of our modern economy.
I believe the American people will decide that we should enact policies that seek to curb growing inequality and provide some check on market excesses.
The writer is Democratic chairman of the House financial services committee
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