Why Dodd-Frank is Dud-Blarney

by Chidem Kurdas

It is a shame that Christopher Dodd  did not become a lobbyist earlier, before he teamed up with Barney Frank to sponsor the Dodd-Frank Act. Mr. Dodd first helped set into motion a fast-expanding web of obscure bureaucratic dicta for almost all financial activity, then took a lucrative job as Hollywood lobbyist.

As Richard Epstein writes in National Affairs, the new financial law is notably vague and broad, granting vast discretion to government bureaucracies, giving them the wherewithal to waive or soften requirements for some parties while riding hard on others. 

Thus the rulemaking to implement Dodd-Frank created immense opportunities for influence peddlers—they might celebrate the great contribution Mr. Dodd made to their bottom line before he joined their ranks.

The WSJ reports that Dodd-Frank rulemaking by various agencies has already resulted in more than three million words in the Federal Register, though most of the 387 mandated sets of rules have not even been put forth.  Behind the mass of almost incomprehensible decrees are impenetrable deals that favor the politically connected and savvy.  

Meanwhile, the Obama administration is putting on a show of getting rid of “dumb” rules in certain limited areas. Thus the Environmental Protection Agency is to stop subjecting milk containers to the same standard as oil containers.  The Securities and Exchange Commission and the Federal Communications Commission, as independent bureaucracies, were not required to identify their “dumb” rules. They did not do so.  No doubt they’re too busy making new ones, as are other agencies.   

The impact of Dodd-Frank will likely be systemic, as the main rationale for the law was to foster financial stability by adding to the regulation of systemically important financial entities. It is not clear how too-big-to-fail firms are identified beyond their being, well, big. Whatever set of criteria is cooked up, it is bound to become obsolete if financial services evolve and systemic roles change, as they have in the past.

But finance may become stagnant, caught in the intricate net of rules. Oligopolies, identified as systemically important, will be discouraged from taking risk but will benefit from government backing. Small firms and newcomers, with no such backing, will have a hard time competing. The lethargy will infect the economy, dampening job and income creation.

A simple and transparent law to expeditiously shut down failing large organizations would  have been useful. An international agreement to this effect with other financial hubs would have limited the damage in failures of global companies like Lehman Brothers, as would have reforming bankruptcy law.  Instead, Congress and the Obama administration chose to fashion an elaborate bureaucratic straitjacket with unknown effects.

Professor Epstein points out that “intrigue always arises when the government is in a position to dole out or deny benefits”  and this corrodes the rule of law and the legitimacy of the regulatory state. James Madison made a similar point—inevitable corruption accompanies the political giving out of goodies and indulgences.  

Dodd-Frank is a dud because its benefits are mysterious and uncertain while the costs, in particular the damage to the rule of law from expanding bureaucratic arbitrariness, are predictable. It’s blarney because there is no evidence that regulators will or can protect us against financial interests or crises. Smooth talk about clamping controls on rampaging Wall Street camouflages the out-of-control growth of government and associated cronyism. Who will protect us from the rampaging regulatory state?

Mr. Dodd’s new clients in Hollywood could make a horror movie of his legislative legacy.

16 thoughts on “Why Dodd-Frank is Dud-Blarney

  1. There are many good points in Chidem’s post. I’ll single one out: the impact of DFA on smaller banks and the small businesses to which they lend.

    The rule making will be an impossible burden for smaller banks. They will not be able to afford to hire the people needed for compliance. DFA will lead to even further consolidation in banking. And, yes, it will lead to more banks TBTF.

  2. When everyone (always) fails, the only survivors will be those the government saves.

    At that point, they WILL be the government, and vice-versa. And we, formerly customers, will be beneficiary/victims (the same thing at that point).

  3. Chidem,

    I think you’re addressing something important. I think Dodd-Frank is really bad. And Epstein is right to express pessimism over “government by waiver.” As Epstein notes, Dodd-Frank makes “systemic” means whatever the regulators want it to mean. The Dodd-Frank Act creates the “Financial Stability Oversight Council,” which has broad powers to identify “systemic” financial institutions and apply to them special regulatory restrictions. The list of specified criteria the council shall use to decide whether an institution is “systemic” includes, “any other risk-related factors that the Council deems appropriate.” In other words, you are a systemic institution if and only if we say so. To call our system “crony capitalism” seems too mild.

  4. A law to shut down failing large banks wouldn’t be a credible commitment anymore, and bankruptcy resolutions are never simple and expeditious (quite the opposite actually)… unless it’s done by the FDIC with according extraordinary powers and (almost) no judicial review.

    Since there are no hint of a viable definition of just what systemic risk is besides a nice buzz word, it’s not a surprise gov agencies were granted vast discretionary powers.

  5. Jerry O’Driscoll–
    Yes, at minimum, the average cost of compliance is higher for small banks simply because it is spread over a small scale. That higher cost, of course, will necessarily be passed on at least in part to the small businesses they lend to.

  6. Roger Koppl-
    The degree of arbitrariness this involves may be unprecedented in financial regulation, a result of both the vagueness and broadness of the central provisions of Dodd-Frank. By comparison, a law to facilitate the winding down of large financial companies would have been specific.

  7. Mathieu Bedard-
    Re “Bankruptcy resolutions are never simple and expeditious (quite the opposite actually)..”
    Yes, but bankruptcy law could be changed to simplify to some extent.

  8. I guess simplified procedures are always good, but I’m not sure simplicity and speed are important characteristics of a bankruptcy resolution scheme, maximisation of the assets’ value usually is the paramount characteristic. The only reason simplicity and speed have been as much discussed is because that’s where the FDIC’s comparative advantage lies. The FDIC basically solves bankruptcies that would have lasted 10 years on Chapter 7 within a few working days, with every depositor, insured or not, systematically covered. That’s as fast and as simple as it gets really.

  9. Mathieu Bedard-
    The issue here is the unwinding of a complicated investment bank– Lehman Brothers’ bankruptcy is the reason the issue came up and a main rationale for Dodd-Frank, though most of D-F is about other matters. So the question is, whether a law to simplify bankruptcy would have been an efficient way to do this. It was not attempted, to my knowledge.

  10. I should add that Lehman is in Chapter 11, not Chapter 7, and it could go on for years. The legal fees have long surpassed $1 billion. This would be the kind of drawn-out process that a reform of bankruptcy law would aim to prevent.

  11. I hear you, and I’m sorry for insisting on what is barely a sentence in great blog post. What I’m saying is that there already is such a bankruptcy resolution process, involving the FDIC and somewhat mimicking the process of a Chapter 7 bankruptcy, and the Dodd-Frank act gave further powers to the FDIC to make bankruptcy resolutions even more expeditious and simple. This process, however, involves a receivership or a conservatorship, allows for barely no judicial review, and can be a source of ‘systemic risk’ as it does create further uncertainties and might even trigger firesales. I have no doubt that Chapter 11 & Chapter 7 could be further simplified and accommodated to the needs of systemically important financial institutions, and there are certainly some important debates about for example what happens to collaterals detained by failed banks. But I’m not sure whether speed and simplicity are an important part of such a process, given the way speed and simplicity have been handled by the FDIC, and that the prime concern of bankruptcy usually are not speed and simplicity but maximization of the asset’s value.

  12. You have a point, Mathieu. I agree there is risk in the FDIC process. What I was trying to get at is a court process instead of an administrative process (as with FDIC), but not the way it it currently done. I don’t see that from the creditors’ perspective the “maximization of the asset’s value” is achieved by staying in bankruptcy year after year. After all, the creditors include parties whose property is tied up in the bankruptcy and who can’t touch their assets for all those years.

  13. Thank you for this post.

    I am surprised this bill has not garnered more sustained attention from market supporters. The bill effectively enjoins government and the largest banks; it is a symbiotic relationship which socializes losses by nebulous and hidden decree.

    Readable financial statement information along with accurate audits, so foundational to markets, is already impossible (Exhibit A: Lehman). Now top tier banks and anyone else politicians deem worthy will be preserved ‘for the common good.’

    If anyone believes that preserving trillions of imprudently made loans on the Balance Sheets of banks is at least partially responsible for our weak economic recovery, this bill should scare us even more, for it systemizes the disease.

    And as we all know, regulation diseases tend to metastasize. Markets are complex systems which give us innovation and economic growth. They can not survive if we do not preserve them.

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