Yesterday, I spent some time listening to academics speak about Dodd-Frank. I don’t think Americans really know how corrosive Dodd-Frank is. It’s killing our economic growth in ways that most people don’t understand.
One thing I have noticed over the years is when there is a crisis, it’s a really bad time to pass sweeping legislation. The momentum and justification for legislation comes from fear. “We don’t want that to happen again”, supporters say. For example, 9/11 happens and we get the Department of Homeland Security which is mostly a waste of money and allows the government to pry into all kinds of places it shouldn’t.
Dodd-Frank is a result of the financial crisis. There are so many bad actors in this crisis that it’s hard to list them all, but the root cause was the implicit backing government gave Fannie Mae and Freddie Mac-along with legislation and regulation that encouraged bad behavior. Sure, the ratings agencies were paid by the big banks and slanted the playing field. The big banks knew exactly what they were doing with the mortgages. But, without the implicit backing of government, the game never gets played.
Most people don’t understand the financial services industry. Heck, many people don’t understand their bank statement. Maybe they will understand and appreciate this quote from Ayn Rand.
“Money is the barometer of a society’s virtue. When you see that trading is done, not by consent, but by compulsion–when you see that in order to produce, you need to obtain permission from men who produce nothing–when you see that money is flowing to those who deal, not in goods, but in favors–when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you–when you see corruption being rewarded and honesty becoming a self-sacrifice–you may know that your society is doomed. Money is so noble a medium that does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot”
This is the society that Obama has set up for us. The grifters. If you want to know how it works in practice, come to Chicago or Illinois and try to start a small business. The level of scrutiny, regulation, and most of all under the table cash payments is legendary. I once knew a person that built a skyscraper here. They included exact percentage over and above the traditional budget for graft.
Let’s start off with the premise that in a perfect world, no regulation is best. Knowing full well we don’t live in a perfect world, we need regulation. More importantly, we need some good regulation. The problem lies in who defines what “good” is. This is key to understanding how bad Dodd-Frank is for the US.
Dodd-Frank radically changed the way the US regulates every financial service company. Insurance companies, banking, clearinghouses, payment processing, credit cards and data. Most of the burden for complying with these regulations went to institutions that didn’t cause the problems. Yet, they still bear the brunt of the cost for the increased scrutiny.
In the insurance industry, it took what was basically a state regulated industry and nationalized at least one third of it. Knowing full well that the more local you can make markets, this goes against any serious economic theory of an efficient marketplace. Supporters will say nationalizing insurance regulations outweighs the cost. Given what is happening in the marketplace, it’s hard to take them seriously.
Here are some data points:
- Before Dodd-Frank 75% of banks offered free checking
After Dodd-Frank 25% of banks offered free checking
- Small business costs are up 15% to comply with new regulation
- 15% less credit card accounts, and a 200 basis points more in cost
Remember, many small businesses get started by using credit cards. You might think they are stupid. But why should you import your financial/moral compass on them. Maybe they see the annual percentage rate credit card companies charge as cheap compared to the opportunity that lies ahead of them.
In the state of Missouri, there were 44 banks with less than $50M in assets. Prior to Dodd-Frank they were profitable. Post Dodd-Frank, 26/44 are losing money and will either go out of business or be consolidated. Your local community bank which is often the lifeblood of local capital is dead. How many other states are like Missouri? It’s no wonder small town rural America is having a tough go in the Obama epoch.
Dodd-Frank tried to make central party clearing mandatory for all transactions in the OTC market. Professor Craig Pirrong has blogged brilliantly about this and other aspects of Dodd-Frank. It works for a few, but not for all. This makes it more expensive to hedge risks. Businesses pass along the cost to consumers. In many cases, clearinghouses have to become the actual counterparty to the hedge. This stops commerce and more importantly has created more too big to fail institutions. Those too big to fail clearinghouses are now backed by the full faith and credit of the American taxpayer, you.
Central planning has killed jobs, increased and centralized risk, and shackled innovation.
Dodd-Frank has unleashed the powerful forces of capricious government. Post passage the Obama administration kicked off Operation Choke Point. It’s a joint initiative from ideologically focused people inside the Department of Justice and FDIC. Their mission: Cut off serviced that businesses need to survive.
How do they decide which businesses to let live, and which are to die? It’s based on whether the bureaucracy “likes” or “doesn’t like” the activity the business is engaged in. What the hell is that? Shouldn’t the future of a business be determined by whether it’s customers like or don’t like their activity?
The Federal government can force banks to quit extending credit to entire sectors of the economy. Think about that for a moment. Think about how a business might view that power. Do you think a business might “get in line” when their government overlord tells them too?
This is why you are seeing so many settlements with the Department of Justice. Banks are paying millions of dollars for “crimes” by settling out of court. By the way, it’s not just banks. Their opportunity cost of litigation is higher than the settlement. The government isn’t taking the money into the US Treasury and paying off debts. It’s redistributing it to very hard left wing organizations.
Government can kill people’s way to make a living and put them out of business. It can stop businesses from starting. All based on the personal preferences or political edict from a top down government.
Why is this a big deal, the banks deserved it right? Maybe they had it coming but it doesn’t make it right. In addition, the rules and regulations are causing non-market based incentives inside institutions. They are exponentially increasing costs which get passed on to consumers. In an information age, businesses that have sensitive information might become even more highly regulated. Why? Fear of cyber attack.
The proof is in the data. We have record numbers of people not working. GDP is anemic. We have a record number of people on government assistance. This isn’t Bush’s fault. This isn’t the fault of the crash of 2008.
Where do we go from here? The Republicans talk a lot about repealing Obamacare, but they need to repeal Dodd-Frank as well. It would be nice if some Democrats that were able to think critically got on board too.
Here are some trends I am seeing in financial services industry silo over industry silo.
- Consolidation-smaller players are forced to merge in order to survive. Bigger players are cherry picking and buying niche smaller players. However, they aren’t paying full value because the smaller player doesn’t have a lot of competitive bidding for the business.
- Higher capital requirements. More and more cash is mandated on the balance sheet. This increases consumer costs and slows growth. Generic risk analysis rather than market based risk analysis is killing the American economy.
- More detailed reporting. This costs money and time for companies to let the government see what they are up to. Audits are fine-but now government auditors are living inside institutions. Of course, that helps them with Operation Choke Point too.
- More and More and More Regulation. There were so many blanks left out of Dodd-Frank. Regulators are now filling it in. When the regulations are bad, they rewrite and redo creating even more regulation.
- Fear of Litigation. Tort lawyers jumped for joy when Dodd-Frank was passed. Companies move slower and more deliberately to make sure they don’t run afoul of a regulation that could line a tort lawyers pocket.
For the short term, we are screwed. However, I can see where startup companies can come in and take advantage of some opportunities. I also am even more bullish Bitcoin/Blockchain than I was before. Blockchain will disintermediate a lot of the functions vertical financial silos do, and do it far cheaper with less risk of cyberattack.
The market always finds a way around really bad laws. It just takes time.