Saturday, November 27, 2010

How To Improve the Financial Reform Law

Here, Oliver Hart and Luigi Zingales offer their vision of how to improve the Dodd-Frank financial deform bill known as The Wall Street Reform and Consumer Protection Act .  I suspect that most people who aren't directly involved in the financial services industry or the banking industry have very little knowledge about what the 2,000 page Dodd-Frank  bill made federal law.

As Hart and Zingales note, "The Fed can now unilaterally decide that any financial institution is “systemically important”—meaning that its failure could destabilize the financial system itself—and impose any sort of regulation on it, such as requiring that it hold more equity capital, limiting the amount of short-term debt it can issue, forcing it to write up a living will, and so on."

The bill further entrenches power in the Fed to manipulate financial markets, as if the Fed didn't already have that power.  But this aspect is but one of the troubling features of the Dodd-Frank financial deform bill.  The bill also sets up a complete czar who is empowered to dictate rules about consumer credit.  In the end, the financial deform bill further codifies control over financial markets in the hands of the few and the powerful.

It is utterly exasperating that the Dodd-Frank financial deform bill did nothing to address a very real problem --- the so-called "too big to fail" problem and future taxpayer bailouts the federal government will doubtlessly impose whenever the few and the powerful are threatened with loss of wealth.

Of course, the official mantra that we are all supposed to believe is that banks and other companies in the financial industry must not be allowed to fail, because of their "interconnectedness."  The notion is that If ABC bank fails, and if ABC bank owes XYZ bank money, the failure of ABC bank could also bring down XYZ bank.

Implicit in this "contagion" domino theory of financial markets is that for some reason, XYZ bank should not suffer risk of failure.  In other words, XYZ bank should be empowered to hold risky financial securities issued by ABC bank with impunity.  Instead, you and I should bear the risk of loss while XYZ bank just enjoys the profits if ABC bank does not not fail.

But why should XYZ be sheltered from risk in the first place?  Why shouldn't it be up to XYZ bank to manage its risk of purchasing financial securities issued by ABC bank?  Moreover, what is never said by the Fed and Congress is the simple fact that even if both ABC bank and XYZ bank fail, the nation has hundreds of banks that manage risk properly who will not fail.  Those banks didn't buy ABC bank's securities in the first place --- precisely because they were such risky assets.

The contagion theory of financial markets is a fraud perpetrated by the few and powerful upon the masses of we the people.  The failure of even very large banks would not destroy our economy.  We have bankruptcy laws.  Financial markets are far too robust for that outcome.

But failure of large banks and other financial institutions could wipe out substantial wealth of the few and powerful.  That's why Congress created the Fed in the first place, at the behest of the few and the powerful in 1913.  Learn more about it here (video) or here (print).

Since 1913 Congress has protected the few and the powerful who operate in financial markets.  You and I can lose our money investing in financial securities, but not the few and the powerful.  It's not that they are too big to fail; it's that they are too powerful to fail.

Goldman Sachs comes to mind. But quite obviously, Lehman Brothers was neither too big nor too powerful to fail.  Too bad for Lehman Brothers.  Martha Stewart suffered a similar fate.  She also isn't part of the few and the powerful.

How could Congress improve the Dodd-Frank financial deform bill?  Repeal it entirely.  Financial businesses, including banks,  would function just just fine, if they were restrained by to the discipline of competition and the very real possibility of financial loss if and when they perform badly.

If regulation works so well to bring us stability in financial markets, how is it that we got Bernie Madhoff and AIG?  How is it that we got Fannie Mae and Freddie Mac?  How is it that we got the S&L crises of the 1980s and 1990s?  How is it that we got the Great Recession, a recession that is widely understood to be the direct result of Congress and the Fed?

Are we too far gone to recover our liberty from the few and the powerful?  We the people made a start in November 2010.  Will we continue with further progress in 2012?  You and I will decide; joining the New Blood Party would be a great way to keep the momentum going.

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