Sheldon Richman on Dodd-Frank Financial Legislation

President Obama has signed the financial industry regulatory overhaul – officially, the Dodd-Frank Wall Street Reform and Consumer Protection Act. Predictably, what he said about it cannot possibly be true.

For example: “[T]hese reforms represent the strongest consumer financial protections in history. And these protections will be enforced by a new consumer watchdog with just one job: looking out for people – not big banks, not lenders, not investment houses – looking out for people as they interact with the financial system.”

And: “[B]ecause of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes. There will be no more tax-funded bailouts — period. If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy. And there will be new rules to make clear that no firm is somehow protected because it is ‘too big to fail,’ so we don’t have another AIG.”

Note that Obama did not promise to spare the taxpayers from having to foot the bill for the government’s mistakes. He and the members in Congress know better than to make that howler of a promise. Nevertheless, the magnitude of the whoppers being told about this law is astounding.

The government cannot deliver on pledges to protect consumers in the financial markets and to shield taxpayers from bailouts. In the first instance — consumer protection — financial instruments are inherently complex and government attempts to shelter less-sophisticated investors and borrowers from all danger would either require control of products to the point of prohibiting things people want or inundating them with information until they ignore all of it because of the sheer volume. Alas, what the new law will provide consumers is a false sense security – and that’s worse than none at all...

Most generally, the new law exhibits the standard governmental hubris. Who truly believes that an army of necessarily myopic bureaucrats can ever know enough to 1) anticipate a systemic crisis and 2) do something intelligent about it in a timely way? The more centralized the power the more vulnerable we average taxpayers are. Mistakes are system-wide. The virtue of a freed market is not that it’s unregulated (it’s not) but that its radically decentralized...

It’s Dodd, by the way, who said of his bill, “No one will know until this is actually in place how it works.” And Frank is ready to submit new legislation to fix any mistakes in the law. We’re about to have a laboratory experiment of the law of unintended consequences.

Obama said: “For years, our financial sector was governed by antiquated and poorly enforced rules that allowed some to game the system and take risks that endangered the entire economy.” The implication is now we have up-to-date rules that will be vigorously enforced. But he can’t possibly know that. Why not? Because in writing the law, Congress did not write the rules. It merely handed that job off to unelected, unaccountable bureaucrats in a variety of agencies.

read the entire essay

Cartoon: Financial Reform

Cartoon: Dodd-Frank Financial Legislation

Cartoon: Financial Reform

Bureau of Consumer Financial Protection

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The law gives the government authority to take over and liquidate failing financial firms, injects transparency into transactions involving financial instruments called derivatives and will restrict banks from making risky bets with their own capital. It directs agencies to write hundreds of new rules...

Mr. Obama's choice, expected soon, will be a momentous one because the first director will have great influence over agency's direction, wielding a roughly $500 million annual budget that doesn't require approval from Congress.

The new consumer regulator will be funded by the Federal Reserve and have independent powers to write and enforce rules governing how loans and other financial products are offered, bearing on everything from the type of mortgages people can get to the fees on their credit cards.

The agency will be able to enforce its rules against any bank with more than $10 billion of assets, as well as all large mortgage lenders, student-loan companies and payday-loan firms. It will have an army of examiners to probe these companies' practices. Small banks will have to follow the new rules written by the agency but they will be examined by other federal regulators.

The bureau's policies and rules could be overturned by other regulators only if they "would put the safety and soundness of the U.S. banking system or the stability of the financial system of the U.S. at risk."...

Supporters said the government needed new powers to protect Americans from abusive financial practices such as hidden fees in the fine print, which they argue helped cause the financial crisis. Opponents said the agency was a sign of "nanny state" that treats regulators as better equipped than citizens to make decisions...

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My thoughts: What could go wrong with a 2,000 bill with "barely understandable fine print"?

Financial Reform: Barely Understandable Fine Print

President Obama signed into law on Wednesday a sweeping expansion of federal financial regulation….

A number of the details have been left for regulators to work out, inevitably setting off complicated tangles down the road that could last for years…complex legislation, with its dense pages on derivatives practices….

“If you’ve ever applied for a credit card, a student loan, or a mortgage, you know the feeling of signing your name to pages of barely understandable fine print,” Mr. Obama said.

from the NYTimes

Financial Reform Won't Stop Next Crisis

Legislators will have a stark, simple choice: support a bill that gives us more of the same flawed banking regulations, or reject it in the hopes that new congressional leadership next year will address the actual causes of the financial crisis.

Perhaps it should come as no surprise that Sen. Christopher Dodd and Rep. Barney Frank, the bill's primary authors, would fail to end the numerous government distortions of our financial and mortgage markets that led to the crisis. Both have been either architects or supporters of those distortions. One might as well ask the fox to build the henhouse.

Nowhere in the final bill will you see even a pretense of rolling back the endless federal incentives and mandates to extend credit, particularly mortgages, to those who cannot afford to pay their loans back. After all, the popular narrative insists that Wall Street fat cats must be to blame for the credit crisis. Despite the recognition that mortgages were offered to unqualified individuals and families, banks will still be required under the Dodd-Frank bill to meet government-imposed lending quotas...

The legislation's worst oversight is to ignore completely the role of loose monetary policy in driving the housing bubble. A bubble of such historic magnitude as the one we went through can only occur in an environment of extremely cheap and plentiful credit. The ultimate provider and price-setter of that credit was the Federal Reserve. Could anyone truly have believed that more than three years of a negative real federal-funds rate — where one is essentially being paid to borrow — would not end in tears?

As the Federal Reserve's monetary policy is largely aimed at short-term borrowing, the Fed also drove the spread between short- and long-term borrowing to historic heights. This created irresistible incentives for households and companies to borrow short — sometimes as short as overnight — and lend long. Many households chose adjustable-rate mortgages that would later reset as interest rates rose, increasing monthly payments. For banks, this spread provided an opportunity for handsome profits by simply speculating on the yield curve.

read the entire essay

Financial Reform Bill Signed into Law

President Obama will sign into law Wednesday the Wall Street reform bill -- the most-sweeping set of changes to America's financial regulatory system since the 1930s.

The legislation will vastly reform the way big financial firms do business.

This is "reform that will prevent the kind of shadowy deals that led to this crisis, reform that would never again put taxpayers on the hook for Wall Street's mistakes," the president said last week.

The bill aims to strengthen consumer protection, rein in complex financial products and head off more bank bailouts...

The legislation would establish a Consumer Financial Protection Bureau inside the Federal Reserve that could write new rules to protect consumers from unfair or abusive practices in mortgages and credit cards.

The bill creates a new council of regulators, lead by the Treasury Department, that would set new standards for how much cash banks must keep on hand to prevent them from triggering a financial crisis. It would also establish new procedures for shutting down giant financial firms that are collapsing.

The measure would put new limits on Wall Street banks' speculative bets for their own accounts and their ability to own hedge funds, while leaving the door open for some investment activities.

read the CNN article

Cartoon: Financial Reform

Major Financial Legislation

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New Financial REgulations Won't Fix Anything

The financial reform bill currently working its way toward President Barack Obama's desk for signing is being touted as the biggest overhaul of the banking and investment sectors since the Great Depression.

But the new regs won't be any more effective than the ones they replace in fixing anything or preventing the next major panic for at least three reasons.

1. New Watchdog, Old Tricks

They create a new watchdog consumer agency designed to protect consumers from their own supposed stupidity. You'll now be facing fewer choices when it comes to getting credit cards, loans, and doing other basic financial transactions.

2. Never Too Big To Fail

They replace "Too Big to Fail" with... "Too Big to Fail." One of the reasons why major financial institutions played Russian Roulette with the economy was because they were betting they would get bailed out. Which is precisely what happened. The new rules codify the idea that the government will make sure certain institutions can never fail. And if you think the big boys won't game that system, then you don't understand how well Citigroup, Goldman Sachs, et al have come through the current meltdown.

3. Housing Bubble Trouble

The financial crisis was set into motion by government policies that encouraged people to buy homes they couldn't afford at prices that were unsustainable. Between desperate attempts to keep people in houses and to keep interest rates below an effective rate of zero, the government continues to pour more money down the same rathole.

Markets work best when the risk and reward incentives are clear cut. When investors know they really can lose it all, they act responsibly with their money. If regulators think they can create a system that cushions us from bad decisions and doesn't encourage bad behavior, it's a delusion we'll all be paying for for a very long time.

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Cartoon: Financial Reform

Financial Reform and the Briar Patch

In 1971 George Stigler published his “Theory of Economic Regulation” in which he hypothesized that regulatory agencies tend to be “captured” by the organizations they are regulating, so that the regulated organizations benefit at the expense of the general public.

Stigler’s capture theory of regulation is playing itself out again in the financial market regulation that is currently being considered by Congress.

read more here

Cartoon: Wall Street Reform