More Regulation or More Relevant Regulation?

With all the turmoil in the financial markets, I would feel negligent if I did not comment in one way or another on the matter. However, since that would probably take an hour to do, I'll just give a quick couple comments and links to two good articles. First, the articles:

"More regulation will harm, not help, recovery" by Gerard Baker

I especially like this line: "But it is more likely to require not aggressive government intervention, but simply the insistence on better provision of information to avoid the chaos created in the past year because investors didn't have a clue about the quality of many of the assets that they held."

"The Post-Lehman World" by David Brooks

As far as I can tell, there are three main problems that have been driving the crisis: 1) asymmetric information and a lack of transparency in financial markets, 2) implicit guarantees by the government for companies (including Fannie Mae and Freddie Mac) which were supposedly "too big to fail," and 3) ineffective regulation (this means too much regulation where there should be less, too little regulation where there should be more, and also just plain bad regulations).

The government implicitly guaranteed that Fannie Mae and Freddie Mac would not be allowed to fail, and not only did it fail to oversee how Fannie Mae and Freddie Mac were buying up tenuous mortgages (including mortgages for which the borrower did not have to give proof of income), but the government actually encouraged, through various laws passed in the recent decade or so, Fannie and Freddie to target less credit-worthy people to get loans. Then Fannie and Freddie sold these mortgages to other banks, where nobody in the transaction had any real idea about the fundamentals of the asset they were buying. How likely was the buyer to make payments? How likely was the buyer to default? Nobody had any idea, because this private information was not made known to all parties involved, or more specifically, the information was asymmetric. These investment firms then created assets which were based on these mortgages, and sold these assets to yet other parties, and soon we had layers of assets being bought and sold, all based on the original tenuous mortgage, and nobody having any idea how much risk they were taking on. In fact, not only did they not know how much risk they were taking on, but they did not even care (enough), because they believed (correctly, as we now know) that the government would bail them out if the risk became reality.

In short, the government encouraged lending institutions to give out loans to people who were not credit-worthy, implicitly guaranteed that these institutions would not be allowed to fail, and failed to ensure that financial markets were transparent, meaning that most players did not know how much risk they were taking on when they purchased assets based off of these bad mortgages.

Does that mean we have a lack of regulation? Yes and no. Yes, in the sense that we need better accounting rules and more transparency in financial markets. No, because regulations are also what encouraged these bad mortgages to be given out, and also because existing regulations helped shape the accounting framework that we have now, which has clearly failed.

Addendum: Blaming the crisis on greed is a lame critique. Businesses, entrepreneurs, and regular citizens always try to make money and profits, so claiming that sometimes they are more greedy than other times is just plain wrong, and not the cause of financial panics.