IT’S been more than two years since the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by Barack Obama. Passed in the aftermath of the financial crisis, and involving some of the most significant changes to regulation since the Great Depression, regulators have been writing rules at an astonishing pace ever since.
At this point, it’s worth taking a breath and asking, “Where are we going, anyway?” The unwelcome answer is that the US is proceeding down the same road that led it to the financial crisis in 2008.
Dodd-Frank did not address the issue central to the crisis – the US government’s deep involvement in housing finance. Implicit government guarantees of mortgage giants Fannie Mae and Freddie Mac became explicit during the crisis. Yet the only acknowledgement of the issue in Dodd-Frank was a mandate to study the issue further. The Obama Administration released a brief report, with three pages of recommendations in February 2011, but has done nothing since. In the interim, the problem has only become worse, with 90 per cent of American mortgages now guaranteed by the government.
Dodd-Frank also solidified the government’s alliance with the largest financial institutions – a troubling phenomenon that bore its rotten fruit during the bailouts of 2008. On the most basic level, the sheer mass of regulatory obligations created by Dodd-Frank protects large firms by serving as a barrier to entry for small, innovative financial institutions. Large firms, with armies of lawyers, are better able to keep up with the new regulations.
More subtly, this alliance manifests itself in the directive that certain financial entities are subject to special regulation by the Federal Reserve. All big banks are in this class. The added layer of regulation will be costly, but it comes with a priceless too-important-to-fail certification from the government. In this vein, the Fed’s unwavering support for its troubled charge Citigroup foreshadows bailouts to come. And the inevitability of the survival of these firms gives them a funding advantage over their non-designated competitors. Creditors are more willing to lend when they know that the government stands behind the debtor.
As a consequence, the largest financial institutions have become the equivalent of state corporations. They are guaranteed a lucrative survival and, in return, they adhere to a complex set of sometimes unwritten regulations governing their mix of borrowers, the scope of their activities, and even the positions they are permitted to take on public policy issues. Big banks will increasingly spend their time trying to please government officials, not consumers. With more than 40 per cent of US deposits in the largest five banks, we are well on our way to a market dominated by the largest institutions.
Dodd-Frank also solidifies the central role of regulators in financial markets. It is infused with unwarranted confidence in the ability of regulators to foresee future crises, and to act in time to prevent them from coming to pass. The new Financial Stability Oversight Council, which brings together the heads of all the financial regulators, is charged with this mission on a grand scale.
And regulators have welcomed Dodd-Frank’s invitation to aggressively interpret their missions. The Commodity Futures Trading Commission (CFTC), for instance, intoxicated with its new responsibilities for over-the-counter derivatives, is angering international counterparts by its insistence that its jurisdiction is unbounded. In our interconnected world, any transaction anywhere in the world could – in the words of Dodd-Frank – “have a direct and significant connection with activities in, or effect on, the commerce of the United States.” Never mind that the CFTC’s capabilities (before the crisis, the agency relied on fax machines to receive data) are not up to the task of monitoring the US, let alone the rest of the world. Another regulator, the almost entirely unaccountable Bureau of Consumer Financial Protection, is wielding its power in a way that will harm consumers by forcing them into the plain vanilla products and services blessed by bureaucrats who do not appreciate consumers’ unique needs.
In sum, Dodd-Frank is speeding America’s trip down the road towards government management of the financial markets and taxpayer responsibility for losses. We ought to turn around and head towards a place where market participants make their own choices, and bear their own losses.
Hester Peirce is a senior research fellow at the Mercatus Centre at George Mason University.