The Dodd-Frank Bill: What People Are Saying and Why Most Are Wrong

Includes: KBE, KRE, XLF
by: Tom Brown

The looming enactment of the misbegotten Dodd-Frank bill, all 2,300-plus pages of it, may count as a legislative victory for the White House and Democrats in Congress, but evidence that it’s a political victory is scant. (Fully 80% of those surveyed by Bloomberg say they have little or no confidence the bill will prevent or even soften a future financial crisis.) Nor will the bill be a big win for the economy. If anything, it will hinder the recovery and weaken the financial system.

Indeed, despite all the hype from the president and his minions (about more of which in a moment) most knowledgeable observers agree that the new law will not prevent another financial crisis. No reasonable person should expect that it should. By its very nature, the financial system relies on leverage and investor confidence. As the experience of 2008 shows, that can be an unpredictable and volatile mix. So no matter how many times President Obama says otherwise, the new law won’t ban financial doomsdays. As his own FDIC chairman, Sheila Bair, says, “No set of laws, no matter how enlightening, can forestall the emergence of a new financial crisis down the road.”

Sheila needs to have a chat with the president. He seems to be one of the only ones who’s under the illusion that the bill is some sort of cure-all. “Because of this bill,” he intoned just last week, “the American people will never again be asked to foot the bill for Wall Street’s mistakes.”

Actually, that’s already wrong. Taxpayers are still on the hook for the bad mortgages guaranteed and owned by the two entities (and key causes of the crisis) the new law studiously ignores: Fannie Mae and Freddie Mac. Their ultimate losses figure to be much, much higher than any bailouts provided to date.

So, no. The law won’t prevent future bailouts or future crises. Rather, it’s a sort of Rorschach Test onto which observers can gaze and see almost anything. There has been a ton of commentary from policymakers about the bill, much of it wildly at odds and sometimes downright contradictory. But it’s all highly revealing. Here are some highlights, along with my take:

Sen. Chris Dodd: “It will take the next economic crisis, as certainly it will come, to determine whether or not the provisions of this bill will actually provide this generation or the next generation of regulators with the tools necessary to minimize the effects of that crisis.”

My take: This is the guy, remember, who was so involved in writing the law that it’s actually named after him—and he’s admitting that no one in Congress knows how effective all the new rules and regulations will be until the next crunch hits. Comforting!

Sen. Dodd, again. “I can’t legislate integrity. I can’t legislate wisdom.”

My take: Let’s just say that if anyone can’t legislate integrity, it’s Chris Dodd. This is the same fellow, remember, who as head of the Senate Banking Committee received sweetheart mortgages from the very banks he was supposed to be overseeing—and then stonewalled reporters who asked questions! It’s all well and good for Dodd to write “reform” legislation now, after disaster has struck. But we’d all have been better off if, as the housing bubble inflated, he’d been more serious about providing proper oversight of the banks rather than taking handouts from them.

Elizabeth Warren: “The new law guarantees the agency meaningful autonomy. It has a protected funding stream, an independent director appointed by the president, and strong rule-writing authority.”

My take: And she just can’t wait to run it! The CFPA is one of the worst parts of the Dodd-Frank bill. It will be one of the juiciest, most powerful fiefdoms in the federal government. The head of the agency will be appointed by the President for a five-year term, have guaranteed funding from the Fed’s budget (which is self-funded, not audited, and not subject to Congressional appropriation, remember), and have broad powers to establish and enforce “consumer protections.” Yet this individual will be accountable to no one. That’s too much unchecked power to vest in one person. If the head of the CFPA promulgates overly restrictive rules on, say, mortgage or credit card lending, he (or she) might push the economy into recession single-handedly.

Elizabeth Warren: “I would like to see a world with two-page mortgage disclosures, two page credit card agreements, and two pages over draft contracts.”

My take: Liz! One reason lending documents are so long and unwieldy as it is is because of disclosure requirements put in place via legislation, rulemaking, and court decisions. If the two-page documents you dream about ever came to pass, consumer lending would essentially stop. In a society as litigious as ours, no two-page document can provide either adequate legal protection to the lender or adequate disclosure to the borrower.

Harry Reid: “Wall Street rigged the game. They put our money on the table. When they won, they won big. But when they lost--and boy did they lose big--they came crying to the taxpayers for help.”

My take: Reid doesn’t let the facts get in the way of a good story! The only firms that came “crying to the taxpayers for help” were AIG, Bear Stearns, Chrysler, Fannie, Freddie, General Motors, and Lehman Brothers. Of those, the only ones that “put taxpayer money on the table” were Fannie and Freddie—the two firms that were so blatantly ignored in the reform bill! As for the rest, none were funded via insured deposits or guarantees. So they weren’t betting taxpayer money. And when they collapsed, shareholders paid a huge price. Reid is simply wrong.

Valerie Jarrett: “If the President had not acted boldly, our banking system would have collapsed.”

My take: Somebody needs to draw Jarrett a timeline. The decisive policymaking that prevented the collapse of the system came at the end of 2008 with the passage of TARP, when George W. Bush was still president. Whether you approved of the program or not, TARP injected hundreds of billions of dollars into the banking system and made it clear clear that the federal government would and could do whatever was necessary to save the system. To his credit, then-Senator Obama voted for the TARP. But by the time he became president, the moment of crisis had passed; all that was left to do was to begin mopping up.

Valerie Jarrett: “If [President Obama] had not stepped in boldly and helped the automotive companies that were in deep trouble, we would have lost millions of jobs.”

My take: But the reason the auto companies were in trouble in the first place was that they’d been run into the ground by managements that had agreed to lavish their unionized workforces with uneconomic wage and benefit packages. The companies deserved to fail. (And remember that Ford, to its everlasting credit, has managed to survive without a federal lifeline.) Instead, GM and Chrysler are doomed to limp along as wards of the state, and will steadily hemorrhage jobs along the way. They’ll almost certainly end up as American versions of British-Leyland. If President Obama had really been interested in sustaining a prosperous auto industry that could create and sustain thousands of jobs, he would have allowed the companies to go through the normal bankruptcy process so that they could emerge with rational competitive labor-cost structures.

Tim Geithner: “These reforms will help level the playing field, allowing community banks to compete more fairly with the nation's largest financial firms.”

My take: Actually, the opposite of this is true. The legislation formally creates a multi-tier system of banks. The largest banks (those with over $100 billion in assets) will be subject to oversight by the CFPA, and will be the most likely to be deemed “systemically important” and thus liable to unilateral seizure by regulators. In addition, the interchange fees charged by large and medium-sized banks banks (those with over $10 billion in assets) will be subject to regulation. Community banks will see little in the way of new regulation. Whether the creation of these multiple tiers is a positive or a negative for community banks is an open question. On debit interchange, for instance, community banks will still be free to still charge retailers what they’d like. Then again, those government-enforced price cuts might cause some retailers to only accept debit cards issued by the big banks. No one knows. Regardless, what the new law does not do is create a “level playing field.”

Tim Geithner: “[The bill’s reforms] will help restore the great strength of the American financial system which – at its best – develops innovative ways to provide credit and capital, not just for our great global companies, but for the individual with an idea and a plan.”

My take: Oh, hogwash. The bill won’t “restore the great strength of the American financial system.” It will constrain it and slow its growth. For instance, the creation of the CFPA (not to mention the fact that the bill will not preempt state laws) will reduce financial innovation, and will make credit—especially credit to individuals and small businesses—less available and more expensive. As to large banks, they’ll see their cost of capital rise, not least because the suppliers of bank capital will have to contend with the new risk that banks can be seized at any moment by the federal government. Geithner is talking through his hat.

But it turns out that not everyone is kidding himself about the effects the bill will have. A number of individuals see it for the mess that it is. Here are two:

Harvey Pitt: “This legislation fixes nothing, accomplishes nothing yet promises everything.. . . . We have the classic legislative monstrosity which Congress and the Administration will claim ‘solves’ the problem, but in reality solves nothing.”

Sen. Richard Shelby: “We have empowered a lot of the regulatory bodies that failed us before and the question is what have they learned.”

Amen to that. The banking system is used to being regulated, and will find a way to earn ample returns under the new system. But fees to costs to consumers are about to go up, and credit is about to become more expensive and less generally available. All the while, the problems the bill is designed to solve still aren’t solved. I don’t see why any of this is a good thing—and am at a loss to understand why people are pretending otherwise.