End It, Don’t Mend It
Tuesday, April 5, 2011
Evidence against the Dodd-Frank Act continues to pile up. Now 18 Republican Senators have introduced legislation to repeal the act.
Last week, 18 Republican Senators, led by Jim DeMint of South Carolina, introduced legislation to repeal the Dodd-Frank Act. It’s surprising that it took so long. The evidence against the act continues to pile up.
Where to begin? Here are a few of the major features of the Dodd-Frank Act that raise questions about whether it should remain in force:
• It strips the banking industry of the ability to engage in proprietary trading (the trading of fixed-income securities for the banks’ own accounts), a profitable activity that no one ever claimed had any role in the financial crisis. Removing the entire U.S. banking community from this market will reduce liquidity and widen spreads for all buyers and sellers of these instruments. Ultimately, it will move this business offshore, where foreign banks and other institutions will gain the benefits. No other country has moved to impose such a restriction on its own banks.
• It authorizes a group of regulators, the Financial Stability Oversight Council, to designate certain large financial institutions—insurance companies, insurance holding companies, securities firms, banks, bank holding companies, hedge funds, finance companies, and others—as potential causes of financial stability and thus too big to fail. This would give these companies major competitive advantages over smaller companies, particularly in funding costs, and forever change the competitive nature of our financial system.
Although the act was sold as necessary to prevent another financial crisis, there is little evidence that the 2008 crisis was caused by a lack of regulation, or by the absence of the draconian restrictions on U.S. financial institutions outlined here.
• It could ultimately give the Fed the authority to regulate and supervise all these too-big-to-fail firms—including their capital, leverage, liquidity, and activities—and thus control the major financial institutions in the U.S. economy. This extraordinary power makes possible something that has never before existed in the United States—a partnership between the government and the nation’s largest financial firms, in which the government protects them from failure and they support the government’s policies.
• It imposes new and costly regulations on derivatives, which many financial institutions and others use to hedge their risks. Jamie Dimon—the chairman of JP Morgan Chase and a former supporter of the administration—probably had these restrictions on a key risk management tool in mind when he called the act “one of the most irrational pieces of legislation I've ever seen,” and predicted it would drive users of derivatives to Singapore to make their derivatives arrangements.
• It creates the Consumer Financial Protection Bureau (CFPB), which has the power to regulate and control all relationships between financial firms and consumers, from the biggest banks to the smallest local check-cashing store. This agency has the broadest mandate and longest reach of any agency in Washington, yet it has been placed completely beyond Congress’s ability to control it through the power of the purse (the CFPB does not require appropriations; it is entirely funded by the Fed). The CFPB is also beyond the control of the president (who appoints the head of the agency for a five-year term, removable only for cause); and although the CFPB is housed in the Fed, the Fed is statutorily forbidden to interfere with its work. So one of the most powerful agencies ever created is wholly independent of the elected branches of government, seeming to violate the constitutional scheme for the separation and balancing of powers.
• It requires the regulatory agencies to produce well over 200 regulations, which will take years. Meanwhile, the uncertainties created by the absence of regulations interpreting the broad language of the act are likely to be the principal reason for the agonizingly slow recovery of employment from the recent recession. As former Fed Chairman Alan Greenspan showed in a recent paper, businesses are not investing cash flows in long-term assets at anything like the rate they had invested in other recoveries since World War II.
Finally, although the act was sold as necessary to prevent another financial crisis, there is little evidence that the 2008 crisis was caused by a lack of regulation, or by the absence of the draconian restrictions on U.S. financial institutions outlined above. Instead, government housing policies, which the act did not even address, fostered the growth of 27 million subprime and other low-quality mortgages—half of all mortgages in the U.S. financial system that year. When these mortgages began to default, the losses weakened financial institutions around the world and caused the financial crisis.
Accordingly, it is reasonable to view the Dodd-Frank Act (like ObamaCare) as an ideological effort to put government in control of another sector of the U.S. economy, rather than as a valid attempt to prevent another crisis. If so, this raises questions about the act’s legitimacy, making it easy to understand why Republicans—virtually none of whom voted for the act—now want to repeal it.
Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute.
FURTHER READING: Wallison also covers “The Foolish Foreclosure Moratorium,” explains “When Economic Policy Became Social Policy,” and observes “The Troubling Resolution Revolution.” In October, AEI hosted “What Have They Done? Implications of the Dodd-Frank Act,” in which two panels debated the merits and shortcomings of the Dodd-Frank Act.
Image by Rob Green/Bergman Group