Institute for Financial Transparency

Shining a light on the opaque corners of finance

18
Apr
2017
0

The Dodd-Frank Act is a con

In response to the financial crisis that began on August 9, 2007, the US Congress passed the 2,000+ page Dodd-Frank Act.  The Act was designed to look like the Obama Administration and Congress were doing something significant while at the same time having as little impact as possible.

The Act was an exercise in expectations management.  The core idea driving the legislation was to con taxpayers into believing all the sound and fury related to the Act actually meant something significant was being done.

For example, included in the Act was the Volcker Rule.  As former Fed Chairman Paul Volcker described the rule, bankers were to be forbidden from gambling with insured deposits.

Who could argue this rule was a bad idea?

The rule only suffers from one small problem:  enforcement.  By the time the bank regulators were done turning this simple rule into a regulation, they had created a 70+ page regulation that required over 700 additional pages to explain how to interpret and enforce.

It is pretty safe to say if it takes more than one paragraph to explain how to interpret and enforce a regulation the chances the regulation will be enforced as intended is effectively zero.

If the Obama Administration and Congress actually wanted the Volcker Rule to be enforceable, they would have required the banks to provide current exposure detail transparency.  With this disclosure, the market could see if bankers were gambling with insured deposits and exert discipline to end this activity (after all, nothing attracts market participants like the opportunity to profit by minimizing the profitability of a bank’s proprietary bets – see London Whale).

Another example of the Dodd-Frank Act as a con is the section preventing future taxpayer funded bailouts of the too big to fail banks.  This isn’t remotely believable.

Recall the justification for bailing out the banks was to prevent a second Great Depression.  Having a section preventing future bailouts doesn’t mean we might not find ourselves in a situation where the financial regulators are going to want to use this justification again.  If they do, wouldn’t taxpayers want Congress to repeal this section of Dodd-Frank and approve another bailout?  As Barney Frank said, the Act isn’t carved in stone.

If the Obama Administration and Congress actually wanted to end future bailouts, they would have required the banks to provide current exposure detail transparency.  With this disclosure, market participants can assess the risk of the banks and limit their exposure to each bank to what they can afford to lose.  Then, if we have another crisis, we don’t have to bailout the banks.  Rather, we can let the viable banks continue in operation while closing down the no longer viable banks without fear of contagion.

While I have a long list of additional example showing why Dodd-Frank is a con, let me conclude with its reliance on the Fed for supervision of the large banks.  When the financial crisis picked up steam in September 2008, Fed Chairman Ben Bernanke observed that all but one or two of the largest banks was insolvent.

Does that sound like the Fed was doing a good job of supervision?

Clearly the authors of Dodd-Frank thought so.  They expanded the Fed’s role in supervision of the financial system and required the Fed add stress tests to its supervisory responsibilities.

Why would the authors of Dodd-Frank think this?

It was part of the ongoing con policymakers had been pursuing since the financial crisis picked up steam.

In one of his final speeches, Ben Bernanke admitted the original stress tests were a con to try and restore confidence in the financial system.  He acknowledged in the speech the Fed did not have the information it needed to know if the banks were solvent or not.

So why did the stress test con work?

At the time the Fed released the results of the 2009 stress tests, it observed the US Treasury would invest as much taxpayer money as was needed to maintain the solvency of each bank that passed.

Outside of DC, nobody believed then or believes now in the results of the stress tests.  What they believe is unlimited amounts of taxpayer money will be poured into any bank that passes.