“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.” – Frederic Bastiat
“The Law of Unintended Consequences is a fact of life. Humans act when acted upon and generally in their own interest. People and markets adjust their behavior – often in ways not predicted or planned for.” – themarketswork
President Obama signed the Dodd-Frank legislation into law, all 2,300 pages of it, in 2010. The legislation was in response to the financial crisis of 2008 and was intended to decrease risks to our financial system and “promote financial stability”. Obama told the public Dodd-Frank would “lift our economy”. He also told us that the financial crisis of ’08 was the result of deregulation.
Sadly, the exact opposite was true. The financial crisis of ’08 – like so many before it – was the result of regulations – bad ones – implemented by Washington over many years.
Our federal government decided decades ago that home ownership was inherently “good” – and should be promoted and subsidized. Many Acts and policies have been implemented over the years such as Section 235 and 502 and the Emergency Home Finance Act of 1974. The federal government also gave us Ginnie Mae – created in 1968 to promote home ownership by federally insuring home loans – and Fannie Mae & Freddie Mac – established in 1968 & 1970 respectively, to purchase and pool mortgages into Mortgage Backed Securities or MBS. The National Affordable Housing Act of 1990 set forth an actual policy objective of home ownership. President Clinton furthered this objective with his stated goal of increasing home ownership rates to record levels before the end of the century.
There are a couple problems with this policy approach to home ownership. First, most of the federal housing policies were created in response to periods of weak economic conditions – such as recessions, mini-recessions and downturns. However, like all things government, there is a lag effect. By the time many of these regulations were put into actual effect, the cyclical downturns they were meant to address had already passed – but the regulations stayed in place for decades. Secondly, and of far larger effect, was the assumption of risks and costs by the government in order to push and subsidize the home ownership objective – which means we assumed those same risks and bore those same costs. This was accomplished by guaranteeing mortgage loans, by lending at below market rates and reducing down payments. In other words, the federal government created new mortgages at below market levels while increasing risk and then subsidized the whole process with taxpayer money. This was further exacerbated by an extremely accommodative Federal Reserve which kept interest rates artificially low for too long which only served to increase the size of the already burgeoning housing bubble.
Said another way, the federal government prompted a lowering of mortgage underwriting standards and effectively encouraged people to buy homes they really could not afford.
And so, the financial housing crisis of 2008 hit us and hit hard – it had been building for literally decades. Rather than look inward, the federal government looked for others to blame, so they targeted the obvious culprits – the banks who were doing the lending on behalf of the government. A quick, but important, side note here – a study by George Mason University reported that financial regulation did not decrease in the decade leading up to the the ’08 financial crisis – financial regulation actually increased by a rough average of 17.5% in the ten years leading to the ’08 meltdown. The fault for the crisis was the federal government and its policies and interventions.
Enter Dodd-Frank. As noted by the George Mason study – At “more than 360,000 words in length, the Dodd-Frank Wall Street Reform and Consumer Protection Act is the longest and most complex piece of financial legislation in American history.” (emphasis mine).
No one fully understood what was in the legislation when it was signed – let alone its full impact on markets. Its stated goal was to “promote financial stability” and “end too big to fail” financial institutions. Instead, the opposite has occurred. The regulations contained within Dodd-Frank are so vast, complex and costly that only the largest of institutions are able to cope with them. Local financial institutions (community banks and credit unions) – the ones making small business loans – have been pushed out of existence by Dodd-Frank. Remember free checking accounts? Before the ’10 regulation most banks offered them – now less than 40% do so. And banking fees have increased as well.
Much worse is the systemic risk Dodd-Frank has introduced into our financial system. Proprietary trading by banks is banned under Dodd-Frank’s “Volker Rule” which has led to dramatically lower liquidity in the corporate debt market – a market which is one of the primary drivers of economic growth for our country. Financial risk has been concentrated into fewer financial institutions and the regulation of derivatives markets has created “clearinghouses” which have now been designated under Dodd-Frank as…”too big to fail”. In other words, we now guarantee them. Again.
Dodd-Frank contains provisions that place large financial institutions under the effective control of government simply due to their size. This has led to government regulators actually being involved in the business decisions of these institutions. It has also led to a pervasive believe that these institutions will be “bailed out” by the government if another crisis hits. Only now, the financial institutions are larger and more concentrated. Exactly the opposite of what was supposed to have occurred.
And who is in charge of this whole mess? Government bureaucrats. The Consumer Financial Protection Bureau (do not believe the title) has almost autocratic authority and no oversight – from anyone.
The true and full effects of Dodd-Frank are still not completely known. We are discovering them as we go. But this much is clear – increased and complex regulation always produces unintended and undesirable consequences that harm our economy. What is also clear is that Dodd-Frank has produced exactly the opposite effects from those intended and has done so at an immense cost.
President-elect Trump has stated that he wants to repeal or at least simplify Dodd-Frank. His newly nominated Treasury Secretary Steve Mnuchin has specifically targeted Dodd-Frank and the Volker Rule stating:
“the number one problem with Dodd-Frank is that it’s way too complicated and cuts back lending…people don’t know how to interpret it. So we’re going to look at what do with it, as we are with all of Dodd-Frank.”
Amen to that. Dodd-Frank is an ill-conceived, knee-jerk legislative response to a crisis now passed. But like all regulation, Dodd-Frank is still being felt. And we are still paying its many costs.
As the great economist Milton Friedman said:
“The government solution to a problem is usually as bad as the problem.”
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