Dodd-Frank Finance Reform? Are They Crazy?
The fact that Senator Chris Dodd and Congressman Barney Frank, two of the prime suspects in the subprime mortgage collapse, had the nerve to put their names on a finance reform bill is bad enough. That it's on the verge of passing is surreal; indeed, with Dodd and Frank leading the way on "finance reform", the inmates really have taken over the asylum.
Like so much legislation in the age of President Obama, it does exactly the opposite of what it's touted to do. Rather than "protect the little guy" it hurts him. Rather than "punish" the rich it effectively fattens them further. Rather than taming the violent ups and downs of the business cycle it offers false assurance to investors.
But first things first. The Congressional Budget Office has estimated the ten-year cost of the bill at roughly $19 billion. Democrats initially sought to pay for this with a tax on banks. Massachusetts Senator Scott Brown opposed this, so the Dems went back and concocted a fix that, if a corporation tried it, would get its accountants frog-marched out of their offices in cuffs. The bill “cancels” TARP a few months early, thereby “saving” the government about $11 billion.
But was the government actually planning on spending it? Not as far as we can see. We've heard not a hint of any administration plans to make more TARP loans. The $11 billion, spread over three months, is a concocted number meant to stand in for theoretical losses on non-existent TARP loans. Congressman Spencer Bachus, ranking member of the House Financial Services Committee, says the only way for this accounting gimmickry to work is if the administration knowingly plans to make bad loans in the next couple months that would cost taxpayers $11 billion dollars. With this proposal, Democrats are tampering with the law to turn TARP into a slush fund for new government programs.
The other funding device Democrats have cooked up is higher FDIC assessments that hit banks large and small alike, despite the fact that FDIC's revised authority supposedly only covers large ones. These assessments will hit small banks, and their customers, hard.
Then there's the Volcker rule, which curbs “proprietary trading” by government-insured depository institutions. But its vague wording leaves banks and holding companies vulnerable to the whims of unelected federal regulators, who will have enormous discretion over what gets defined as prop trading. If Congress really wants to outlaw certain investment vehicles, let it pass laws specifically designed to address them, rather than leave government bureaucrats to cherry-pick enforcement.
The Dodd-Frank bill also creates something called the Financial Stability Oversight Council, which is supposed to detect the next crisis before it reaches critical mass. But, human nature being what it is, all it will likely do is create the false impression that government has things under control (when does government ever have things under control – except perhaps those things it has no business trying to control in the first place). This only encourages complacency and inattention in the banking industry by catering to bankers' worst instincts, and giving them someone or something to blame in the next melt-down.
Republicans in the Senate have fought hard to keep a short leash on Dodd-Frank's FDIC, so that it can't bail out creditors of big financial players indiscriminately. But the bill is shot through with exceptions and loopholes. The FDIC will still have authority to broker GM-style transfers of corporate assets that cater to political insiders instead of legit creditors. Dodd-Frank also further entrenches the Federal Reserve's right to extend credit to financial institutions in distress. Theoretically the Fed only uses this power for firms with liquidity problems short of insolvency. In practice the distinction is blurry at best. Regulators charged with maintaining a firm's financial integrity will be tempted to efface it further come the next crisis (as Bush Treasury secretary Hank Paulson did when he forced both weak and healthy banks to take TARP money).
Dodd-Frank creates another new agency, the Consumer Financial Protection Bureau (CFPB) which would have virtual carte blanche to mandate job-killing regulations. Though part of the Fed in the org charts, the CFPB would be a de facto independent agency, with the power to right its own rules and enforce them. We all support reasonable consumer safeguards, but must they be an excuse for yet another stifling bureaucracy? The CFPB could very well constrict credit access for small business, and put in jeopardy our already anemic economic recovery.
Predictably, the corporate-governance component (“proxy access”) of Dodd-Frank gives Big Labor tremendous new powers that it will use to strong-arm countless mom-and-pop investors. Even those who support the concept of “shareholder democracy” ought to realize this isn't the way to bring it about. Who stands to benefit most? Politically powerful activist groups like the AFL-CIO and the SEIU. Ordinary shareholders? Not a chance.
While compromised risk assessments by the top credit-rating agencies (CRAs) were a key ingredient of the financial crisis, Dodd-Frank leaves intact the current CRA cartel. If we had the courage to decertify the worst of the CRAs, it would go a long way toward repairing the credit markets and restoring consumer confidence. That ought to be our goal. Dodd-Frank is an egregious dud on this issue.
Excessive institutional use of debt (leverage) to artificially boost the profitability of real-estate investments made the mortgage crisis much worse than it would have been otherwise. Since then, experts and policymakers have proposed several worthwhile changes to the regulation of leverage – none of them included by Democrats in Dodd-Frank, unless you count the toothless restrictions on federal regulators sponsored by Senator Susan Collins – which still leaves us DOA on regulatory reform and as vulnerable as ever to overleveraging.
Echoing Nancy Pelosi on healthcare, Senator Dodd said "No one will know until this is actually in place how it works." This is particularly true of the new derivatives regulation it proposes. But the creation of clearinghouse exchanges for credit-default swaps begs the question of whether they too won't become, like AIG, "too big to fail."
Which brings us to Fannie Mae and Freddie Mac. It is both outrageous and piercingly ironic that the two organizations most directly responsible for the housing bubble are not mentioned in the 2,300 page legislation. These GSEs, cosseted in federal conservatorship, have built up debt obligations in the trillions of dollars. The cost of saving them will far surpass that of TARP. Where are the tightened restrictions on their operations? Where are the caps on their credit lines? Where is the planned abolition of their charters? Sadly, they are nowhere to be found in Dodd-Frank.
Is this really the best congress can do to reform the financial services sector? Consider that Democrats spent only 14 calendar days on it in their rush to get the bill to President Obama before July 4th. There's no good reason to hurry through this work. There's one bad political reason – Democrats know full well the November elections are going to dramatically change the composition of both houses in ways unfavorable to them. Any reforms written after that will be far less to their liking.