Chris Dodd, everybody’s favorite hairdo, has introduced a “tough” financial “reform” bill that he claims will “limit the risk [financial institutions] can assume.” Of course, most people with a pulse realize that a 1565 page bill introduced by one of the top recipients of financial industry lobbyist money in Congress probably will do little to ‘reform’ the financial industry in the best interests of the American people. That, however, doesn’t fully capture the perniciousness of this bill.
When we look at it closely, we can see it is one of the most dangerous bills introduced in Congress in years.
One of the worst parts of Dodd’s bill is that it institutionalizes “too big to fail.” Bank holding companies with assets greater than $50 billion and nonbank financial companies supervised by the Board of Governors of the Federal Reserve are required to pay into a $50 billion “orderly liquidation fund.” (Dodd gave verbal assurance on May 4th that this provision would be eliminated, but Dodd’s bill still needs to be reconciled with the House bill, which contains a $150 billion fund.) Why should a fund be necessary to liquidate a business? Well, to pay off creditors, that’s why. That’s the premise of “too big to fail”: if a large, interconnected firm fails, it could cause the collapse of its creditors, which could in turn cause the collapse of the entire economy. (If you believe that one, I’ve got some land in Florida to sell you.)
The potential bailout of creditors, however, isn’t limited to $50 billion. The FDIC is permitted to pay out the entire $50 billion in the fund and up to 90% of fair value assets of the company in default. If that isn’t enough, the FDIC is authorized to buy and sell securities, with no explicit limit set, on behalf of the company (or companies) to raise additional capital. This gives a huge advantage to the “too big to fail” firms. Their debt is backed by an enormous guarantee. This will obviously serve only to increase their size relative to their smaller competitors, whose debt is not backed by such a generous guarantee.
That is not the only way “too big to fail” institutions come out ahead. Fed chief Ben Bernanke, head of their would-be regulator, assumes they will be exempt from minimum reserve requirements in the new regulatory framework. This will allow them to take on more leverage, precisely the wrong thing to do to stabilize the financial industry. Canada has no reserve requirements and their banks are 50% more highly leveraged than American banks.
Can a “too big to fail” institution fail? Yes, but only if the government says so. The Orderly Liquidation Authority Panel, a panel comprised of three bankruptcy judges from Delaware, a state known for its ‘respect’ of financial regulations, evaluates the suggestion of the Treasury Secretary on which companies should go into receivership. If the panel agrees with the Treasury Secretary, the company is “permitted” to go into receivership. The company can, of course, appeal the decision if they disagree, but why would they want to when their wise overlords have already spoken?
Afraid this bill is only a giveaway to big banks? Don’t worry. It impinges on the lives of common people too! No longer will they have to worry about how to use their own money, because this bill makes it illegal to invest in a new venture or start-up company if they have less than a liquid net worth of $2.2 million or an annual income of roughly $450,000. Don’t worry! It’s for the “safety” of the system, and they were probably too dumb to invest it themselves anyway.
The bill also requires submission of data on any financial activity that poses a “threat” to financial stability. This, as it’s written, could mean anything. The data then goes to the Treasury Department to be used in financial databases. Morgan Stanley estimated that having the government provide these databases for them will save their company 20 - 30% of operating costs. The downside, aside from subsidizing giant banks and hedge funds, is that if the government’s data and assumptions are bad, everybody’s data and assumptions are bad.
The bill also requires any deposit-taking financial institution to geo-code customer addresses and maintain records of deposits for at least three years. Think of the government having a Google map of where you do your banking. The government may then “use this information for any other purpose as permitted by law.”
“Surely,” you may say. “There must be some good part to this bill? What about the Bureau of Consumer Protection? No, not the Bureau of Consumer Protection that already exists in the Federal Trade Commission. I’m talking about the one that Elizabeth Warren espouses, the good one.” Well, it turns out that has problems too.
The Bureau of Consumer Protection will subject smaller community banks to an additional twenty seven regulations. This will surely impose an additional cost on them. The larger financial institutions, however, will not be subject to these regulations. The Bureau of Consumer Protection, moreover, would not only regulate banks. It would regulate “any other business that permits payment in more than four installments or assesses late fees. No wonder the first year’s budget for this new regulator is $410 million.”
There is also the power the Bureau wields. It will be headed by a single director, appointed by the President and confirmed by the Senate. “Once confirmed by the Senate, the director would report to no one and would have the authority to write and enforce rules and decide how to spend his or her massive budget. In fact, the budget would automatically increase each year with no oversight by Congress, the president or, for that matter, anyone else.” Only a two-thirds vote from the eight-person Financial Oversight Council can overturn the director, and this may then be appealed. The Bureau also sets the minimum regulations nationwide. States can enact more stringent regulations, but not less.
There is also the pork in the bill. The primary consumer-protection law for home buyers is the Real Estate Settlement Procedures Act, which prohibits real estate agents from receiving “kickbacks” for steering settlement services. “For example, your real-estate agent cannot, under RESPA, be paid a fee for steering you toward a certain home inspector, title company or other closing service. Yet, under the Dodd bill, real-estate agents would be exempted from RESPA. If that weren’t bad enough, the Dodd bill exempts insurers and attorneys - both now subject to RESPA - from its consumer protections, too.”
There is also an amendment to exclude the captive finance arms of certain manufacturers from the bill’s requirements that derivatives only be traded over exchanges and through a clearinghouse. Only a handful of firms would be excluded - chief among them, of course, the automakers.
There are other reasons to despise this bill, such as it makes the SEC “self-funded” and prevents a meaningful audit of the Fed, but that’s just icing on the cake, on the crap cake. Any possibly redeeming qualities it may have are outweighed by its negatives.
So, what is the solution?
Well, firstly, we need to realize that there’s no such thing as “too big to fail.” We were told that we needed to bailout some banks to keep them lending. What happened after we bailed them out? Commercial bank lending dropped by record levels in 2009, while 45% of banks with assets under $1 billion increased their lending. That is what happens in capitalism. One firm falls down, another one rises up. We cannot let the government decide who wins and who loses.
Secondly, we need to take the government out of the banking and finance sectors. I know some people may say that we have free market capitalism now and that the government is saving us from it, but no we don’t and no it isn’t. Government intervention is exactly what got us into this mess.
In the 1700’s and 1800’s, banks issued their own notes. If a person did not think a bank was sound, they could reject that bank’s notes. This helped keep a check on the banks. The government then said that all bank credit had to be issued in dollars. This decreased the accountability of banks. (Granted, there were bank defaults in the 1800’s, but much of this can also be traced to government prohibitions against branch banking and requirements that banks purchase frequently worthless government bonds.)
We also need to get the government out of deposit insurance. If banks want deposit insurance, they should buy it on the free market, where premiums will vary based on the soundness of the bank. Currently, the premiums the FDIC charges are based on “an opaque “black box” process that cannot be validated by outsiders.” In fact, from 1996 from 2006, the FDIC collected no premiums from banks at all. “[O]fficials believed at the time that the good times would last and that bank failures would not be a problem.”
Lastly, we need to break the government-created ratings cartel. Before 1975, there was a free market in rating debt. In 1975, however, the government instituted the Nationally Recognized Statistical Ratings Organization, which said that any company that wanted to rate debt had to be “nationally recognized.” Originally, only seven companies were “nationally recognized.” Now, we’re down to three.
Every step of the way, the government has centralized regulation. It has said, “We are the only ones capable of making decisions for you. You are incapable.” We can see where that’s led. Every other day there’s some story about a regulatory agency either being corrupt or incompetent. There, of course, can be corrupt and incompetent private companies as well, but the only difference is customers can shut them down with their dollars. It is harder to shut down the government.
If we do not embrace the grassroots regulation of a genuinely free market, we have done nothing to solve this mess. If we let this bill go through, all it means is that we have allowed the government to get even more powerful and that it will invade our lives even more. Eventually, it may even start mandating that we get hairdos like Chris Dodd’s.
And that’d be truly tragic.