Given the difficulty the Republicans are experiencing in their efforts to repeal and replace ObamaCare, they need a roadmap for dismantling the far more destructive Dodd-Frank Act.  What follows is why Dodd-Frank must be dismantled and the roadmap.

The Act is much more destructive than ObamaCare because it undermines the very basis for our capital markets while only benefitting the bankers.

How does the Act undermine the capital markets?

It substitutes the government for the market and ensures that banks will be bailed out in the future.

Under the Act, regulators conduct and publish the results of their annual stress tests of the banks.  The stress tests are suppose to determine if the banks would remain solvent if bad things happened to the economy.  Since the bank regulators first published the results of the stress tests, all the Too Big to Fail banks have passed the test.

A passing mark is the equivalent of the government saying it is safe to buy securities in the  Too Big to Fail banks because they won’t fail even if bad things happen to the economy.

Due to opacity, investors are in no position to second guess the government.  After all, the government has access to information that isn’t available to the investors.  Plus, investors know the passing stress test grade creates a moral obligation on the government to use taxpayer funds to bailout the bank and by extension the investor should anything go wrong with the bank.

The existence of the stress tests and the moral obligation to bailout investors fundamentally undermines our capital markets.  By design, governments are not suppose to say any security is a good investment.  By design, investors are not suppose to be bailed out of their losses.

Instead, investors are suppose to be provided with the information they need to know what they own.  Since they are responsible for all losses on their investments, investors have an incentive to use the disclosed information and exert market discipline on the banks to restrain the banks’ risk taking.

So what should the Republicans do to dismantle the Dodd-Frank Act?

1. Forbid the regulators from announcing the results of the stress tests.
2. Repeal all regulations that substitute regulators for the market including:
   1. The Volcker Rule.
   2. Bank capital regulations (In Transparency Games, I explain why bank capital is an easily manipulated accounting construct only regulators and academic economists care about and how bankers use these regulations to their benefit).
3. Close the following regulatory entities:
   1. Office of Financial Research (it is a barrier to transparency in the global financial markets and another arm of government offering its opinion on what is a good or bad investment).
   2. Financial Services Oversight Council (it is a tool bankers have used for capturing all the financial regulators).

So what should the Republicans replace these elements of the Dodd-Frank Act with?

1. Move all of the Fed’s and OCC’s bank supervision and regulatory responsibilities to the FDIC.  This aligns the regulator’s incentive to minimize the risk to the deposit insurance fund with the taxpayers’ incentive to never have to bailout the banks.  Doing this also reinforces market discipline on the banks as investors know the FDIC has the authority and incentive to close down any bank before it becomes a threat to the deposit insurance fund.
2. Require the Fed in its lender of last resort role to only lend against securities that provide sufficient disclosure so investors can know what they own.  There is never a reason the Fed should blindly gamble taxpayer money on securities the market cannot value.  In practice, these securities would have to carry a label from the Transparency Label Initiative.