Until I began
to examine the Dodd-Frank financial overhaul bill, I had no idea
that it would so significantly change the direction of the United
States. It’s scope is so vast and pervasive that it’s difficult
to grasp its totality. I wrote this article to try to explain this,
and why I believe it’s so important for us to understand it. Because
of its complexity it wasn’t possible to do this briefly, so I wrote
this major "white paper" and divided it into four parts
to make it easier to digest. Please stick with me for the next parts;
your eyes will be opened.
The new financial
overhaul bill is the greatest government takeover of the financial
sector of the economy since the National Recovery Act of 1933 when
Franklin Roosevelt attempted to introduce central planning in America.
More than just
a new law, the Dodd-Frank “Wall Street Reform and Consumer
Protection Act” (the "Act") gives government a relatively
free hand to set prices and wages, to make business decisions, to
promote or eliminate businesses, and to break up businesses. It
establishes a large new bureaucracy to enable the government to
dictate its wishes to the industry.
A major law
the Act as follows:
marks the greatest legislative change to financial supervision
since the 1930s. This legislation will affect every financial
institution that operates in this country, many that operate from
outside this country and will also have a significant effect on
commercial companies. As a result, both financial institutions
and commercial companies must now begin to deal with the historic
shift in US banking, securities, derivatives, executive compensation,
consumer protection, and corporate governance that will grow out
of the general framework established by the Act. While the full
weight of the Act falls more heavily on large, complex financial
institutions, smaller institutions will also face a more complicated
and expensive regulatory framework.
The Act isn’t
directed just at the financial sector; because of its vast scope,
it’s directed against everyone.
it may seem, the Act does nothing significant to prevent the real
causes of this or any future boom-bust cycle. At best one may analogize
this as the doctor breaking the thermometer to cure a fevered patient.
At worst it’s a massive federal power grab which will inhibit financial
innovation, increase the cost of money, and open wide the gates
to a favored few where politicians, politics, and lobbyists, rather
than markets, determine the direction of the financial sector of
While the new
law has been signed by the President, it hasn’t yet been written.
That task will be the job of federal mandarins, the career lawyers
and economists inside and outside of government who live off of
government regulation. As such the ultimate consequences of this
Act are unknown and won’t be fully known until years later after
the regulations have been written, agencies are established, and
power is distributed among the bureaucrats. In other words, the
Act’s advocates have no idea how the new law will impact the
The Act assumes
that the economic bust was caused by a failure of capitalism and
a failure of government to properly regulate the economy.
the Act, President Obama said:
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," Mr. Obama said.
law, he said, would better protect consumers, empower investors
and bring transparency to dark corners of the financial markets.
American people will never again be asked to foot the bill for
Wall Street’s mistakes," Mr. Obama said. "There will
be no more taxpayer-funded bailouts. Period."
and most politicians, Republicans and Democrats, blame the crisis
on capitalism itself, and, rather incredibly, on what they view
as unregulated “laissez-faire” capitalism. They
ignore the fact that the financial industry is one of the most regulated
sectors of our economy. When they say “laissez-faire,”
what they really mean is that they want to completely control the
views Wall Street and free enterprise with disdain, repulsed by
what he sees as just the latest failure of capitalism and the “old
ways and failed policies of yesterday.” He believes, as the
benevolent legislator-in-chief, he must step in and protect us from
evil predations of Wall Street like a shepherd guarding his flock:
Only the guiding hand of government can make capitalism safe for
like most politicians, lawyers, and economists, believes that the
economic bust was caused by greed, excessive compensation, fraud,
speculation, complex securities that no one understood, predatory
Wall Street practices, and a lack of sufficient regulatory powers.
These factors, they say, allowed financial institutions such as
Wells Fargo, JPMorgan, and Goldman Sachs to take unnecessary risks
which jeopardized the world’s financial system and almost brought
is that their beliefs are wrong, and they make up data to fit their
beliefs. Their conventional wisdom fails to satisfactorily explain
the actual underlying causes of this boom-bust cycle and the new
law will do nothing to prevent another cycle. The factors they blame
for the crash always exist in financial markets, and yet, for reasons
they don’t explain, actors on the financial stage suddenly explode
into an orgy of greed directed at the housing market.
There are two
questions you should consider while evaluating the Act’s impact
and scope that help explain this boom-bust cycle:
1. Why did
the housing market become a bubble?
2. Why would
any lender lend money to a home buyer who (i) had a credit score
of 500, (ii) made a down payment of 5% or less, and (iii) didn’t
have to prove his or her ability to repay?
I would answer
these questions by saying:
- Only cheap
money drives bubbles and there’s only one entity that creates
cheap money and that’s the Federal Reserve. From 2000 to 2004,
the fed funds rate went from 6.5% to 1.0% wildly distorting entrepreneurial
behavior. This was the cause of this boom-bust cycle.
- No one
would lend so carelessly unless they didn’t care. They didn’t
care because someone else, in this case the government (Fannie,
Freddie, and the FHA), would guarantee repayment.
stems from these two factors yet there’s nothing in the Act that
prevents the Fed from starting a new cycle or that prevents Fannie
or Freddie from again distorting the economics of the housing market.
The purpose of this article isn’t to go into the ultimate causes
of the bust as I’ve discussed them at length in other
but these factors highlight the foundational fallacies of the Act.
chart gives a good picture of the timing for implementing the
legislation hands off to 10 regulatory agencies the discretion
to write hundreds of new rules governing finance. Rather than
the bill itself, it will be this process – accompanied by
a lobbying blitz from banks – that will determine the precise
contours of this new landscape, how strict the new regulations
will be and whether they succeed in their purpose. The decisions
will be made by officials from new agencies, obscure agencies
and, in some cases, agencies like the Federal Reserve that faced
criticism in the run-up to the crisis.
Futures Trading Commission has designated 30 "team leaders"
to begin implementing its expansive new authority over derivatives,
and has asked for $45 million for new staff. The Federal Reserve,
Federal Deposit Insurance Corp. and Securities and Exchange Commission
are also in the thick of the implementation.
Law firm Davis
Polk Wardwell calculated the number
of agencies involved in the rule making process. In
this chart, the “Bureau” is the Bureau of Consumer
Financial Protection, the “Council” is the Financial Stability
Oversight Council, and the “OFR” is the Office of Financial
Here is the
reality: It will take many more years to write and implement the
regulations that really define the Act. It may be that some of these
regulations will never be written, something that’s not unheard
of in Washington.
The Act will
be a siren call to lobbyists, lawyers, accountants, and economists.
and Perfect Wisdom
impact of any new and unwritten law is uncertainty, and uncertainty
is what business abhors. “Regime
uncertainty,” a concept developed by economist Robert Higgs,
says that such legislation causes businesses to pause expansion
until they know how the law will affect them. This is apparently
of Dodd-Frank could hardly be worse for the fragile recovery.
A new survey by the Vistage consulting group of small and midsize
company CEOs finds that "uncertainty" about the economy
is by far the most significant business issue they face. Of the
more than 1,600 CEOs surveyed, 87% said the federal government
doesn’t understand the challenges confronting American companies.
Secretary Timothy Geithner believes they can regulate us with perfect
Secretary Timothy Geithner vowed the Obama administration would
try to avoid choking off economic growth as it implements the
financial-regulatory overhaul enacted last month and pursues new
In his first
public appearance before Wall Street executives since the Dodd-Frank
bill was signed July 21, Mr. Geithner said the administration
would eliminate old "rules that did not work" even as
federal agencies are writing the more than 200 new rules required
by the regulatory overhaul.
said the changes were needed to curtail "too much freedom
for predation, abuse and excess risk," but said it should
still seek to "safeguard the freedom, competition and innovation
that are essential for growth."
believes in the “just right” Goldilocks philosophy of
regulation. I question that any central planner would have the wisdom
to supplant the decisions of millions of economic actors without
negative consequences. One might say this is a form of arrogance
associated with (almost) absolute power.
Provisions of the Act Are Good"
When we evaluate
the Act it would be a mistake to look at its individual parts rather
than its whole. To look at one provision and say, “well that
sounds reasonable” is a form of political diversion that only
serves to obscure the fact that the thousands of provisions in this
Act taken together vastly enlarge the power of the federal government
and reduce individual freedom. That cannot be good.
I will say
that some of the provisions, in light of the Wall
Street-Washington Financial Complex’s system of crony capitalism,
may actually reduce some risk that we taxpayers will eventually
have to pay for. But that ignores the power and influence of Wall
Street and its friends within government to influence rule-making
to suit their needs (“regulatory capture”).
door between Washington and Wall Street allows people attracted
to power and who are skeptical of the ideals of a free market, to
dominate economic policy for their benefit. One way to say this
is that it creates a partnership between the financial sector of
the economy and the government (which is the controlling partner
in this relationship). In the 1930s this type of political system
was greatly admired in Washington. Today this system has evolved
into “crony capitalism,” an oligarchic structure maintained
by the Wall Street-Washington Financial Complex to perpetuate itself.