Dodd-Frank Follies

When things go wrong we generally ask “What can we do to keep that from happening again”? It’s a normal human reaction, but a prideful one. Those of us who are parents will generally admit that we struggled to correct problems that occurred in our own households. For that matter, it’s tough enough to correct the problems that occur within one’s self.

The larger the social unit, the more visible the problems; the more visible the problems, the greater the urge to believe they can and thus ought to be corrected, as if a simple expression of collective will ought to be enough. But bigness begets bigness, and larger problems are likely to prove even less amenable to correction. We’ve documented the ways in which “Too Big to Fail” regulations produced effects contrary to their intentions. John Steele Gordon comments on the failure of Dodd-Frank:

These are the too-big-to-fail banks. Their failure would ripple throughout the economy and could well cause a financial contagion that would be hard to stop. And Dodd-Frank doesn’t do a thing to solve that problem. Dodd-Frank is 893 pages of legislation and, so far, 9,000 pages of regulation (with 2/3 of regulations yet to come). Regulations, of course, don’t stop bank failure. They don’t stop the moral hazard created by a bank being too big to fail. They don’t stop the competitive advantage that being too big to fail gives the megabanks, with other institutions willing to lend to them at lower rates, knowing that the government will have no choice but to rescue them from failure.

In a high-regulation environment, large and wealthy firms will always have the advantage, both in terms of being able to comply with regulations and having the capacity to “remove the teeth” from regulations. The Nation provides this interesting report explaining exactly how the largest banks marshaled their resources in such a way they could actually turn Dodd-Frank to their competitive advantage. The report is filled with nuggets like this, demonstrating that complexity begets complexity begets non-compliance :

Three years after Dodd-Frank was passed, only 148 of the 398 rules requiring action by regulators have been finalized, and draft versions have yet to be submitted for half of the remainder. Sheila Bair, head of the Federal Deposit Insurance Corporation between 2006 and 2011, is among those outraged at that record. Bair, a lifelong Republican who was picked by President George W. Bush to head the FDIC, is unhappy that Congress wrote such an overly complex law. She also wishes that the regulators would act more boldly. But the main culprit, she says, is the resistance to reform posed by an industry with enormous firepower. “At the end of the day,” Bair says, “the regulators are outgunned.”

The temptation in situations such as this, as I said, is to ask what must be done. My own (layman’s) view is that changes need to be made to the derivatives markets, the bonds ratings agencies, and equity requirements. But I’m not sure how this can be accomplished given the scale of the actions involved. The Commodity Futures Trade Commission, which helps regulate the commodities market and thus matters such as grain prices, is responsible, according to this report, for monitoring transactions totaling some $300 trillion a year: a number so large that it can’t be grasped, much less managed.

Government has multiple goods it is trying to accomplish, and so the desire for transparency and fairness can often complicate greater social goods, as demonstrated here:

The CFTC started publishing draft rules nine months after Dodd-Frank’s passage, offering another chance for the industry to muck up the works. This was the “comments letter” part of the process. Again, consumer advocates and union representatives were free to share their views on whatever the CFTC was proposing, but their lack of resources and boots on the ground meant picking their battles carefully. The big banks, hedge funds and financial trade associations, by contrast, would simply pay a law firm up to $100,000 to research and comment on each proposed rule in letters that ran as long as 300 pages. Savvy financial players know that the 1946 Administrative Procedures Act requires federal agencies to catalog the issues raised and spell out why they are accepting or rejecting each point. The more pages submitted to the CFTC, the more time it would take to methodically sift through every letter. To date, the CFTC has received more than 39,000 reaction letters from the industry, comprising roughly 1 million pages of commentary.

The dynamics between big government and big business/finance generally assures the growth of each, to the detriment of a sound and humane economy on the one hand, and democratic transparency and accountability on the other. I don’t expect that to be reversed any time soon.