Opinion: Carolina Critic

Allison Shows That Damage To Financial System Worse Than We Knew

• Allison, John, The Financial Crisis and the Free Market Cure: Why Pure Capitalism Is the World Economy’s Only Hope, McGraw-Hill, 2012, 289 pages, $28.

RALEIGH — Charlotte-based BB&T is one of the most successful banks in the nation. Its chairman and CEO John Allison took BB&T from $4.5 billion to $152 billion in assets during his 20-year tenure. Now head of the libertarian Cato Institute in Washington D.C., insider Allison has put together what he learned about government and financial regulation in a fascinating new book The Financial Crisis and the Free Market Cure.

His conclusions are these:

• Owning a home is consumption, not investment. This should be obvious to anyone, even politicians. Yet rather than educate the public, they deliberately mislead.

• Government policy is the primary cause of the financial crisis. Acts like Sarbanes-Oxley, the Patriot Act and Dodd-Frank have, or will, make things worse not better.

• Government actions, which often have good results in the short term, almost always have bad results in the long term.

• Government all too often thinks it “knows best.” It knows, for example, that more Americans need to go to college and own houses and electric cars — as opposed to the myriad other things they could do with their time and money.

• The government-mandated, politically driven bank accounting system has become so complex that it conceals more than it reveals. “Even with 40 years’ experience in banking, I cannot fully understand the financial statements of Bank of America,” writes Allison. He doesn’t think anyone else can either.

• Regulation is necessary, but existing regulations inhibit creativity, provide a façade of responsibility, and very often encourage, rather than discourage, bad behavior by financial players.

• Regulators have power without responsibility. When times are good, regulators have a “light touch.” But when a crash happens, they discover rules they neglected to enforce during happier days.

Allison’s banking background gives him particular insight into those shadowy behemoths of finance, the government-sponsored enterprises Fannie Mae and Freddie Mac. Together with the Federal Housing Administration, the Federal Reserve, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission, they were responsible, argues Allison, for the huge misallocation of resources that led to the financial crisis of 2007.

Allison’s personal experience tells him that the GSEs inhibit private banking because they can offer cheaper loans, as they benefit from an implicit government guarantee. That’s not so bad, you might think. After all, they pass savings on to the consumer, right? Well, no. The estimates I have seen show that they pass on no more than two thirds of the advantage they enjoy as government-backed entities.

The rating agencies were one of the main causes of the subprime crisis, and their role largely was scripted by government, Allison argues.

First, the SEC gave three rating agencies monopoly power: “only debt instruments rated by S&P, Moody’s, or Fitch qualify for positive consideration under … rules designed to protect pension accounts.”

Second, “Under government-mandated ‘issuer pays’ rules, the rating firms were motivated to lower their standards, fearing that issuers who were displeased with their ratings would yank their business and move it to a competitor rating firm.” In other words, the government induced a conflict of interest. Even as mortgage lenders were selling dodgier and dodgier “product” to less- and less-creditworthy customers, product ratings remained high.

Allison’s insider experience has provided him with many crony-capitalist horror stories, but the most Orwellian is this one. BB&T was forced to decline a loan to a trusted customer because of new FDIC rules. But the bank could not tell the customer the reason he was refused: “The borrower is angry at BB&T because we cannot tell him that the regulators caused this to happen. The FDIC prohibits banks from using changes in regulatory rules as a reason to change the terms of a loan. …”

Why should a government agency be allowed to protect itself from scrutiny in this way?

Read this book. The damage that has been done to our financial system is worse than you know.