Dodd Financial Reform: Recipe Included
As with other parts of the New New Deal our leaders are peddling, the Dodd financial reform package is a perfect storm of blame game, confusion, and ignorance. As for reform? Not so much. When principled people on the left (Feingold; Cantwell) join ranks with Republicans against a bill, a Potomac sewer rat (excuse me, vole) is in the house. You have to look deep within the bill for its few redeeming features, and these are unlikely to outweigh certain negative results.
First, the bill barely touches on the mortgage industry at the heart of the financial crisis. Second, despite its populist trappings, its 1400+ pages only works to the favor of those parties rich enough to buy the legal army needed to wade through it and comply. Third, the bill does nothing to address bi-partisan concerns about the last Wall Street "reform" courtesy of Messrs. Sabanes, Oxley and Spitzer. This previous set of good intentions all but killed the small cap public equity market and the venture business that depended upon it. Could we fix that mess first? Take a ticket. How about funding innovation? So last century. Finally, a bill this important should be crafted by brilliant public-minded leaders above the political fray and steeped in real world experience. Instead of Louis Brandeis, however, we get a script written in an echo chamber by HuffPo-reading political staffers, corporate shills, and politicians interested foremost in salvaging their own complicit hides.
In a nutshell: this bill will make the Washington-Wall Street nexus tighter than ever and bailouts (by any other name) more likely.
One of the great historical accidents that favored the American capital industry and our economy generally was that our financial center, New York, and other regional centers such as San Francisco, were physically separated from the tinkering (however well intentioned) and envies of Washington. No more. This bill takes another step toward a continental regime of capital + cronies -- Athens circa 2010 by way of Chicago circa 1930. The bill also spins the nausea-inducing yarn that the financial crisis was the result of "wild speculation" and "exotic instruments" on Wall Street. In fact, the crisis was specifically about $2T of mundane (but fake) AAA mortgage securities supported by (a) shaky insurance via a politically-connected well spring (AIG), which the bill barely mentions, (b) a ratings oligopoly sanctioned by the government with no shortage of the same "experts" this bill further embraces, and (c) a government-sponsored secondary market via Fannie Mae and Freddie Mac, which this bill ignores entirely.
Why does the bill place new burdens on private equity funds, venture capital, corporate governance, municipal bonds, credit cards and other matters that are non-systemic in nature and had absolutely nothing to do with the sub-prime mortgage crisis? Any more questions before we shoot that canary making noise in the corner? The response to every wrong (perceived or real), is a flat-footed federal agency with too much authority and too little real experience. Instead of applauding the power of well-policed markets and the native interests and intelligence that drive the vast majority of American business and financial leaders, the bill puts the vain courtiers and egoists of the political court in the center of the financial stage, where they'll expect applause no matter how lame their performance. With broad drivel about "consumers" and "risk" empowering new super-agencies, the rule of law will be no match for a new breed of disastrous do-gooders in the vein of Fannie Mae and Freddie Mac.
Any more question before we begin another reading of Alice in Wonderland?
Let's roll the tape from Senator Dodd's own committee:
- Consumer Financial Protection Bureau. There is no evidence that a financial crisis driven by inflated housing values represented: "an across-the-board failure to protect consumers". This is convenient fiction at best. A harmful lie at its worst. Any "schemes" involved in the crisis were real estate scams by borrowers, builders, and flippers to speculate locally and/or defraud lenders. Inflated housing values? Thank a strong economy, low unemployment and the same low interest rates and ready credit the government continues to promote.
Certainly, some had the misfortune of hitting the top of the housing cycle and/or used low-down payment, NINJA and other ill-advised reset loans. Individuals also lied on loan applications. But who pushed these instruments, juiced the housing market, and eased loan requirements? The same consumer-focused "affordability" advocates that will likely populate the new agency.
I have suggested Luigi Zingales' debt-for-equity swaps and other real solutions to help consumers caught up in bad timing and a bad economy, but this bill's premise belies all the talk we hear now from liberals about how they support "personal responsibility". These are people buying houses, not digging in dumpsters. We should anticipate diligence from them. This bill WILL certainly mean fewer banks, as less will be able to afford to comply with a new federal blanket of rules. Competition will decrease. Consumers will suffer. The same "affordability" advocates that brought us skyrocketing college and housing costs are not the solution. They are a problem. A gratuitous layer of bureaucracy increases costs and decreases the best protection consumers have: the ability to switch providers.
Far from helping consumers, this bill will have the opposite effect.
- Financial Stability Oversight Council. 9 Mandarins, who will "identify risks" and sweep anything deemed "risky" under the Federal Reserve's purview. Bad Idea. Very bad idea.
Chaired by the Treasury Secretary, this new financial Council of Trent will have strange and surprising powers, intermingling monetary, banking and securities functions in a charged political environment. Mind you, we now have a Treasury Secretary, who gleefully admits he "has never held a real job". But not to worry, according to Dodd's release, a new "Office of Financial Research" will be staffed with "highly sophisticated economists, accountants, lawyers, supervisors , and other specialists" Hmmm. What seems to be missing? How about someone who has actually worked in the securities industry or in banking, and not just a vacuum sealed policy environment. To a Washington bureaucrat, stepping outside in a drizzle is a risk. How on earth will they get the risk/reward balance correct with nothing in play? This is classic central planning myopia that has failed again and again. And what on earth is the person who is supposed to watch the federal treasury doing watching every else's treasure as well?
- Ending too Big to Fail Bailouts. Really? Once you get beyond a few lines stolen from the Tea Party, you find a morass of contradictory provisions that do little to forestall bailout nation and completely ignores the elephant in the room.
In reality, almost all the TARP money that went to banks was paid back soon thereafter, and most banks never wanted it in the first place. Who was actually bailed out to the tune of hundreds of billions? Fannie Mae and Freddie Mac. Does this bill have anything to do with Fannie Mae and Freddie Mac? Nada. Zippo. Zilch. There are several dishonest assertions in the bill, but the most disingenuous is the notion that it addresses "too big to fail." By getting Washington all that more in bed with Wall Street, too big to fail really means: you're not connected enough to survive.
Then, the bill proposes a series of half-baked attempts to place proprietary trading, derivatives, hedge funds and private equity funds into one big "suspect" class -- as if any of these are even vaguely related in terms of their risk dynamics and appropriateness for deposit institutions. But don't worry, the Council will sort this out. How? When? Where? Accountable to Whom? The whole construct is ludicrous and smacks of desperation to pass anything and sort out the mess later. Sound familiar?
Does our regulatory regime deserve a makeover? Yes. Does it need a blue ribbon panel of experienced former industry luminaries who love their country and their industry? Maybe. What about a council of Washington mandarins and careerists? No.
- Transparency and Accountability for Derivatives. At long last, we find a provision in the bill that seems to acknowledge something exists that is called a market. Revelation. And perhaps some simple honest policing and transparency would go a long way to making it work better. Hurrah.
Putting aside the misguided analysis about the role of derivatives in the financial crisis, transparent, well-policed markets are an admirable goal of this legislation. If our legislators simply addressed that one element, this would have been a supportable quest. Not surprisingly, this is a provision with actual bi-partisan support, leaving one to wonder why the rest of the bill goes off on an ideological tangent.
- Updating the 40 Act to bring in non-registered public investment vehicles (Hedge Funds) and making sure the role of insurance is understood in securities regulation. Again. No major problem here, but why not look at the whole regime? The hedge fund industry grew up because of the sclerotic nature of 60 year old Investment Company rules. Why not try to understand why the current regulations are so burdensome first? Then, try an overall fix? Isn't this what you should be studying? Isn't this what modernization was supposed to be about? We need MORE funds available to the public, not just a few Fidelity behemoths. See earlier point on Sabanes, Oxley and Spitzer. We need to increase the diversity and activity of equity market participants, not pass rules that stifle the capital markets.
- Credit Rating Agencies. Yes. This is an area that WAS ACTUALLY RELATED to the financial crisis. Of course, without a market-aware approach, it is far from certain that any outcome of this legislation will be positive. The idea of a government actor picking which agencies should provide ratings strikes me as inherently flawed. The reality is that money has to come from somewhere to do the work of rating, and this bill's sop to the plaintiff bar will only increase the cost of research and likely lower its utility. In previous writings, I have proposed something similar to what the National Research Exchange got approved -- a private clearinghouse that handles settlement and establishes mechanisms to avoid conflicts. These are the kinds of measures that could readily get true bi-partisan support and are truly needed changes. Why not focus the legislation on these things? Why bring in the trial lawyers? Why not encourage multiple rating agencies and let smart, institutional investors make their decisions based upon reputation and track record? Again, go ask your mother.
- Executive Compensation and Corporate Governance. Based on nothing more than Paul Krugmanesque Pablum, this bill seeks to federalize state corporate law. I have many issues with state corporate law, but this bill is not the time or place to address these issues. Perhaps a commission on best practices or model codes. Ironically, the anti-shareholder bias of corporate laws coming out of the First New Deal produced the perverse, pro-management incentives we have today. I'm all for strengthening shareholders rights, but these same liberals are jumping up and down about corporate takeovers and want to put private equity and leveraged finance (two major friends of shareholders) into the penalty box. This is an example of the kind of confusion and contradiction that is littered throughout the bill. On the one hand, class warfare rhetoric and a criminalize business and finance mentality borne of envy and ignorance. On the other hand, a few long overdue, but misplaced, changes. Very. Bizarre. Indeed.
- SEC improvements. Ha! This band of miscreants bring up Madoff, who was a major contributor to all their campaigns. The changes suggested are hardly objectionable, but the short shrift they give to the SEC is indicative of the fact (a) they do not trust markets and (b) traditional "Wall Street" had a lot less to do with the crash than the committee reports own rhetoric suggests. This bill envisions a non-market, cryptic uber-Regulator, such as the Federal Reserve, to overlord over all institutions (see below). So much more irony I can hardly take it.
- Securitization. Again, more grating "spin" about companies "selling mortgages to people they knew could not affort to pay them". Excuse me !!! Wasn't that the point of all the affordable housing mandates the government trafficked in? And what about personal responsibility that the majority pretends to talk about now? I dumped my last bonus in to pay down part of my mortgage instead of going on vacations, etc. My neighbor got a principal readjustment and then took off for two weeks to Florida. Why don't you ring up all the behavioral economists and ask them about that "nudge". As for the skin in the game rules, they are not on the face objectionable, but shouldn't institutional investors police this? Shouldn't the market just price up pure agented deals? Again, this is another half-arsed example of a junior staffer that read an article in some weekly news magazine and thought why not? No research. No thought. No discipline. No considered viewpoint. Just a probably dumb idea, we have to live with for the next several decades.
- Municipal Securities. Fair enough. Even a broken clock is right twice a day, and maybe this is one of those times.
- Strengthening the Federal Reserve. This reads like some inside baseball. Or settling some old scores. Tough to tell. The job of the federal reserve in my view is currency. Period. The fed should be subject to full audit. Period. While it is apparent that the $1T purchase of long-dated securities by the Fed in February 2009 accomplished what an ill-conceived TARP could not -- monetize the Fannie / Freddie mess -- we will live to regret the day the Fed believes its new found power should be permanent. With the collapse of the Euro, we now have a Fed that believes monetizing debt might be a palatable solution. In general, this bill heads us in the wrong direction.