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Thursday, 17 January 2013 10:20
Dodd-Frank Act could lead to new financial crisis
Warning from academic on 8,800 page US law

In 2010 it covered 2,500 pages. By its enactment there were 8,800 and many times more the number of sheets containing criticism of this knee jerk reaction to the 2008 financial crisis.

As the legislation ramps up, a new book argues that the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act is fatally flawed and could lead to another collapse.

Dodd-Frank is a massive slate of regulations that expands the role of government to police everything from debit card purchases to insurance.

Dodd-Frank: What It Does and Why It’s Flawed, produced by the Mercatus Center of George Mason University, provides a thorough dissection of the more than 8,800-page law.

“I think it really didn’t get to the problems we saw in the last crisis. In fact, I think it made them worse in many ways,” said Hester Peirce, a senior research fellow at Mercatus and, with James Broughel, co-author of the book.

Peirce maintains that Dodd-Frank created an intricate web of governance, producing uncertainty in many industries.

“There was this need to do something,” she said of the law’s genesis. “Congress was more concerned about doing something than about doing something right.”

By creating new agencies like the Bureau of Consumer Financial Protection and expanding the role of existing entities like the Securities and Exchange Commission, Federal Reserve and others, Peirce said Dodd-Frank puts the nation’s financial health in the hands of regulators while providing little clarity for the rules they enforce.

Among the book’s key criticisms is the law’s underlying philosophy, that some companies are so large and interconnected throughout the economy that their default would result in disastrous market contagion. The authors contend that Dodd-Frank responds with the sort of regulatory overreach that guarantees government protection for companies that, like insurance giant AIG, are considered too-big-to-fail.

Hester Peirce suggests the following ways that Dodd-Frank will hurt the payments business alone:

Codifies Too-Big-to-Fail. Rather than eliminating the market's expectation that certain big financial firms are too big to fail, Dodd-Frank creates an explicit set of too-big-to-fail entities—those selected by the Financial Stability Oversight Council  for special regulation by the Fed.

Threatens Small Businesses.
Dodd-Frank's complex web of regulations favors large financial firms that can afford the lawyers to analyze them. New requirements will be disproportionately costly for small banks and small credit rating agencies. Dodd-Frank's complex derivatives rules will further concentrate an already concentrated industry.

Hurts Retail Investors. Dodd-Frank gives the Securities and Exchange Commission a new set of responsibilities that distracts it from its core mission. New rules impose costs on nonfinancial companies that will be passed on to investors and consumers. Commission resources will be diverted to protecting the wealthiest investors.

Consumer "Protections" Harm Consumers. The consumer financial products regulator established by Dodd-Frank, rather than helping consumers, threatens to raise the prices consumers pay and limit the products, services, and providers available to help them achieve their financial objectives. Various rules, such as price controls on banks' debit charge fees to merchants, are likely to increase bank fees for consumers and drive low-income customers away from basic banking services.

Sows the Seeds for the Next Financial Crisis. Dodd-Frank forces complex derivatives into clearinghouses. These entities will be large, difficult to manage safely, and very deeply connected with the rest of the financial markets. If one of these clearinghouses runs into trouble, the economic ramifications could be massive, which means the government will be tempted to engineer a bailout.

Creates New Unaccountable Bureaucracies. Dodd-Frank establishes several new bureaucracies, including consumer protection, data management, and stability oversight agencies that operate with limited transparency and little accountability to the American people.

More Power for Failed Regulators. Despite their past regulatory failures, Dodd-Frank gives the Securities and Exchange Commission and the Fed broad new regulatory powers.

Unchecked Government Power to Seize Firms. Dodd-Frank allows the government to sidestep bankruptcy and instead seize and liquidate companies. Vague criteria define which companies may be seized, and there is limited judicial oversight of the whole process. The Federal Deposit Insurance Corporation might use the process to prop up failing firms and to favor particular creditors.

Interferes With Basic Market Functions. The Volcker Rule, which prohibits banks from engaging in proprietary trading and limits their investments in hedge funds and other private funds, is proving to be difficult to implement. It will be more difficult to comply with and will interfere with the functioning of the market.

Replaces Market Monitoring with Regulatory Monitoring. Dodd-Frank relies on the hope that regulators that failed before and during the last crisis will be able to spot problems in the future. For example, Dodd-Frank gives broad new systemic risk oversight responsibilities to the Fed and the Financial Stability Oversight Council. It also raises the deposit insurance cap to $250,000, which will discourage large depositors from monitoring banks and correspondingly increase the likelihood of regulatory intervention.

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