More Regulation Is Coming

09/15/2008 12:00 am EST

Focus: MARKETS

Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, says the housing and financial crisis has spurred a rollback of deregulation.

Sadly, the deregulatory trend has been reversed in this decade, and more regulation is following the ongoing financial crises in housing and financial markets and their spreading effects.

A consistent characteristic of regulation is that it comes after the fact, in reaction to abuses and problems. By the time regulation of Wall Street was enacted in the 1930s, investors were so disillusioned with stocks that they had no interest in them for almost two decades. Like all trends, the government involvement in the US economy that started in 1933 got so overdone that by the 1970s, voters reacted.

Deregulation and a shrinking role for government were prevalent in the 1980s and 1990s in financial services, retail trade, telecommunications, and many other areas. But the dot com stock bubble of the late 1990s and the 9/11 terrorist attacks reversed the tide. When the dot com bubble broke and a lot of people lost a lot of money, there was the usual cosmic need for scapegoats. The corporate accounting scandals early in this decade that sunk Enron and WorldCom led to the Sarbanes-Oxley law that added immensely to corporate accounting costs.

In reaction to the [housing and mortgage market collapse and the broadening financial crisis], government involvement in financial markets is mushrooming. Even without the Treasury Secretary's grand plan, the role of the Federal Reserve has expanded greatly, starting last summer when financial markets came close to freezing up. It embarked on a series of measures to make funds available to banks that couldn't borrow from other banks since they were too wary to lend.

Later, that list was expanded to include opening the discount window to investment banks to insure that the run on the bank that sunk Bear Stearns wouldn't recur. Of course, now that the Fed lends to investment banks for the first time since the 1930s, it's only a matter of time until it regulates them.

Already, Fed officials are stationed inside the four major firms and working alongside officials from the Securities and Exchange Commission to oversee those investment banks' operations. If investment banks borrow Fed money just as commercial banks do, why shouldn't they be regulated like their commercial cousins?

So, regulation and government involvement in the economy, especially the financial sector, are growing. Does that negate our earlier forecast of deflation? Probably not. Deregulation is only one of our eight deflationary forces, and was never one of the strongest.

Further, the housing and financial crises that have brought on much of the re-regulation are highly deflationary as they depress financial markets and economic activity. Indeed, severe and widespread financial crises could turn the good deflation of excess supply that we're forecasting into the bad deflation of deficient demand, much as in the 1930s.

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